INTERNATIONAL for Multinational Corporationsan administratively manageable way that would eliminate any potential loopholes for MNCs that may attempt to avoid the cap by restructuring,

THE CENTER FOR CLEAN AIR POLICY

June 2004

Establishing Greenhouse Gas Emission Caps

for Multinational Corporations

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Dialogue. Insight. Solutions.

Frances Sussman

Ned Helme

Cathleen Kelly

The Dialogue on Future International Actions to Address Global Climate Change (FAD) Working Papers

The FAD Working Papers are intended to help advance the discussions on the design of the future international response to climate change. The concepts developed and opinions expressed in these papers are those of the Center for Clean Air Policy (CCAP), although these views have been informed by extensive interactions with participants in the “FAD.” Since October 2002, CCAP has facilitated biannual meetings of the FAD, which brings together a group of high-level climate negotiators from developed and developing countries. The process gives participants a chance to informally discuss different approaches to the design of the future international climate regime in a relaxed, off-the-record, non-negotiating setting. Each FAD meeting consists of one day for participants from developing countries—“Developing Country-Only Dialogue—followed by three days of discussions between developing and developed country participants—the “Joint Dialogue”. Financial contributions for these efforts were provided by the Australian International Greenhouse Partnerships Office, Environment Canada, Canadian Department of Foreign Affairs and International Trade, European Commission Directorate-General for Environment, Korean Ministry of Foreign Affairs and Trade, German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety, Japanese Ministry of Economy, Trade and Industry, Netherlands Ministry of Housing, Spatial Planning and the Environment, New Zealand Climate Change Office, Norwegian Royal Ministry of Foreign Affairs, United Kingdom Department for International Development, United Kingdom Foreign and Commonwealth Office, the United States Environmental Protection Agency, Swedish Ministry of the Environment, Swedish Energy Agency, and Swedish Ministry of Industry, Employment, and Communications. The FAD Working Papers do not reflect consensus recommendations of the FAD participants; rather they are CCAP’s ideas and papers influenced by the discussions in the FAD. Later in the process CCAP will publish a compendium which will include elements of the FAD Working Papers and other options discussed during the FAD meetings. For more information on the FAD, presentations, and other FAD Working Papers, see: www.ccap.org/International_Program.htm#FAD

About the Center for Clean Air Policy

As a recognized world leader in air quality and climate policy since 1985, the Center for Clean Air Policy, an independent non-profit entity, seeks to promote and implement innovative solutions to major environmental and energy problems which balance both environmental and economic interests. The Center’s work is guided by the belief that market-based approaches to environmental problems offer the greatest potential to reach common ground between these often conflicting interests. CCAP staff have participated in the Framework Convention on Climate Change negotiations, helping to shape the Joint Implementation provisions of the Rio Treaty and the Kyoto Protocol Mechanisms. CCAP has also developed a series of papers, the Airlie Papers, on domestic carbon trading in the US, the Leiden Papers, on international emissions trading, and the Clean Development Mechanism Papers, on the design of the CDM. For more information on CCAP, see: www.ccap.org

ESTABLISHING GREENHOUSE GAS EMISSION CAPS FOR MULTINATIONAL CORPORATIONS Prepared by Frances Sussman, Ph.D., Consultant Ned Helme, Center for Clean Air Policy Cathleen Kelly, Center for Clean Air Policy June, 2004

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Acknowledgments The initial idea for this paper arose during a conversation between Ned Helme of CCAP and Yvo de Boer, Director General of the Dutch Ministry of Housing, Spatial Planning, and Environment, who was the first to raise the idea of an MNC cap publicly in a speech at an IETA conference in Washington, DC in the Fall of 2000. During the preparation of this and earlier iterations of the paper, a number of individuals at the Center provided insights and assistance, including Karen Lawson and Catherine Leining (formerly of CCAP and currently with the government of New Zealand). Jin Lee, Mike Pollan, and Anand Rao of CCAP provided research assistance. Marian Martin Van Pelt of ICF Consulting assisted with interpreting the data on greenhouse gas emitting sectors in the United States. In developing the concept for the paper, the authors benefited greatly from discussions with a number of individuals, including David Doniger and Jeff Fiedler of Natural Resources Defense Council, Donald Goldberg of the Center for International Environmental Law, Jurgen Lefevere (formerly of FIELD) and currently at the European Commission, Richard Stewart of New York University Law School, Robert Sussman of Latham and Watkins, Jonathan Weiner of Duke University Law School, and Jenifer Wishart of the International Finance Corporation. These individuals provided many creative suggestions too numerous to attribute completely in the paper. All remaining errors are, of course, the responsibility of the authors.

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EXECUTIVE SUMMARY

The Kyoto Protocol sets emission reductions goals for Annex I countries, but does not require such emission reductions in developing countries, beyond those achieved voluntarily through the Clean Development Mechanism (CDM). Although considerable discussion and analysis has focused on possible mechanisms and measures for reducing emissions from developing countries, one aspect is often overlooked: the emissions in developing countries arising from the overseas operations of multinational corporations (MNCs) headquartered in Annex I countries. While no comprehensive data on the magnitude of these emissions exists, the role of MNCs in developing country emissions is undoubtedly significant, given the sheer volume of investment in energy-related industries in developing countries that originates with these global enterprises. This paper explores a proposal to cap greenhouse gas emissions resulting from the developing country operations of MNCs headquartered in developed countries.

In the latter half of the 1990s, over $200 billion dollars flowed annually into developing countries from various private and public sources in industrialized countries. This flow was equivalent to approximately 4 percent of the combined GDP of developing countries, nearly half of which came from MNCs, which are enterprises with headquarters (i.e., a parent enterprise) in one country and branches or other affiliated enterprises in other countries. Investment flows from MNCs takes the form of Foreign Direct Investment (FDI), which is investment made to acquire or add to a lasting interest in an enterprise, or to an enterprise in which the parent enterprise already has such an interest. FDI is a far larger source of financing than official development assistance for most developing countries, particularly for middle-income developing countries. Among the regions, FDI is largest for Latin America and the Caribbean, and for East Asia and the Pacific.

While no data exist on the energy-intensity of financial flows from all countries to developing countries, the United States data suggests that as much as 40 percent of the operations (measured in terms of value added) of US MNCs in developing countries may be in industries that are energy-intensive or related to energy. These industries include food, textiles, paper, petroleum and coal products, basic chemicals, plastics and rubber, mineral products (i.e. cement), primary metals (including iron and steel), oil and gas extraction, utilities (including electricity generation), and manufacturing of motor vehicles. In addition, the data from Germany also suggests an analogous level of investment in energy-related sectors, although the investment focuses on slightly different sectors. Insofar as Germany and the US together comprise about one-fifth of worldwide FDI to developed countries, the data from these two countries suggest a significant relationship between MNCs operations and developing country greenhouse gas emissions worldwide.

The proposal presented in this paper is a tradable allowance system to cap emissions associated with the operations of enterprises in developing countries that are affiliated with a parent enterprise in a developed country. The proposal works to modify the climate implications of investment flows that are already occurring in a variety of energy-intensive or energy related sectors. Under the cap, covered MNCs would be subject to an aggregate emissions cap (or carbon intensity target) on affiliated enterprises and operations in developing countries. As in any trading system, the cap would establish the aggregate emissions levels and MNCs would be

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required to hold allowances equal to their emissions in the commitment period. MNCs would have the opportunity to trade allowances with each other and in the global markets for Kyoto instruments. Primarily domestically owned companies in developing countries would not be subject to the cap. MNC operations covered by the cap would not be able to participate in CDM, although any emission reducing activities that could have been eligible for CDM credit would either contribute to meeting the MNC cap or free-up excess allowances for sale.

The MNC cap has several possible advantages. First, it has the potential to reduce emissions in developing countries, without raising emissions elsewhere (i.e., because it is a mandatory cap rather than a voluntary credit system). Second, it helps to build capacity in developing countries by instituting emissions inventory and familiarizing them with the principles of emissions trading. Third, it avoids directly placing commitments on developing countries by placing the burden on foreign-owned and controlled enterprises. The cap is also compatible with current proposals to supplement the requirements of the Kyoto Protocol, and complements and builds on company-level efforts to develop internal emissions trading systems and to build capacity in greenhouse gas accounting and related issues. Last, the MNC cap is a means of addressing the perception of “manufacturing flight” to developing countries resulting from the exemption of developing countries from caps under the Kyoto Protocol.

The MNC cap has several potential disadvantages that stem from implementation issues and possible undesirable impacts on investment flows and competitiveness. First, the proposal would cover only part of total emissions in developing countries. Second, foreign-owned companies may lose their competitiveness against unaffiliated domestic companies due to the additional cost of complying with emission reductions under the cap. Higher costs and other restrictions of the cap may increase product prices (possibly for consumers) and/or reduce wage rates in covered industries. Increased production costs may subsequently reduce the flow of investment money or otherwise restrict investment relationships in covered industries in some countries. Overall, these effects would create a disadvantage for the developing country economies. Last, there are a few problems from an implementation perspective. The cap can be controversial because reducing emissions by a domestic company would be eligible for CDM while the same activities would be required for MNC without any credit. It may be also difficult to define a “covered enterprise” in an administratively manageable way that would eliminate any potential loopholes for MNCs that may attempt to avoid the cap by restructuring, substituting contractual for equity or ownership relationships, or any other means.

Capping MNC operations will require the cooperation and enforcement capabilities of the governments of the developed countries in which the parent enterprises are located, as well as the assent of developing countries. Thus, broad features of the system, as well as many of the details of system design, will be determined by the results of negotiations among these countries. In turn, the fundamental legal and political feasibility and viability of the system will be determined by these design decisions, as discussed below.

Framework: an International Agreement. Under the proposal, the cap would be implemented via a treaty or less formal agreement among nations. Under this agreement, parent enterprises within the borders of participating nations would report and reduce emissions of affiliated foreign enterprises. The treaty could take any of several possible forms, including a formal treaty negotiated from an existing platform (such as the UNFCCC or the OECD) or a new platform, or

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an informal multi-lateral “gentlemen’s agreement,” such as the OECD’s Arrangement on Guidelines for Officially Supported Export Credits. The agreement would need to be designed within the restrictions of international law, country-sovereignty issues, and legislative authority in developed countries. In order to reduce the cost of the complying with the MNC cap, it would also be important that the agreement makes provisions for an open system. In other words, the system should allow the tradable instruments of the MNC cap to be compatible with other tradable greenhouse gas instruments being developed.

Definitions of covered enterprise and the possibilities for “gaming” the system. Covered enterprises can be defined along a number of dimensions. From the perspective of administrative feasibility, the ideal definition of an MNC would be one that is commonly accepted, widely used, and consistently applied across countries. A commonly used definition of an MNC is based on the level of ownership in, and control of, the affiliated enterprise by the parent enterprise. This definition could be supplemented by criteria for determining the sector of an enterprise or the location of the parent enterprise (in some few cases an MNC will have headquarters in more than one country), by thresholds based on size (e.g., employees or product sales), and rules for apportioning emissions responsibility among multiple foreign owners. The definition will also need to address methodological considerations, such as how to calculate ownership or equity values.

A critical issue for the MNC definition to address is the potential for “gaming” among MNCs that would restructure themselves in order to avoid the cap. For example, a parent enterprise could sell off an asset in a developing country, and then substitute a contractual relationship with the previously affiliated enterprise. Alternatively, the MNC could avoid the cap by moving the headquarters for the parent enterprise to a country that does not participate in the MNC cap system.

Other design decisions. A complete specification of the MNC cap will also require determining a number of system design elements:

• Coverage of the system, in terms of gases, sectors, and source categories.

• Whether the system focuses on upstream or downstream emissions—e.g., CO2, caps on emissions at the point of combustion (downstream) or at the point of fuel distribution or extraction (upstream).

• The nature of the cap and associated obligations—whether it is a hard cap or dynamic target (such as a carbon intensity target), the stringency of the emission reductions required by the cap, the method of distributing allowances (free distribution or auction), and (if distributed) the formula for allocating allowances to covered enterprises.

The MNC cap proposal is promising in terms of cost, compatibility with existing systems, potential impacts on developing country economies, and environmental benefits. Successfully implementing the cap will require resolving a number of key issues, including legal jurisdiction and the structure of an international agreement, and whether or not MNCs can be defined in a way that both is administratively feasible and prevents MNCs from restructuring or taking other evasive actions.

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TABLE OF CONTENTS

EXECUTIVE SUMMARY .............................................................................................. ii

I. Introduction ......................................................................................................... 1

II. Private Sector Financial Flows........................................................................... 2

III. Establishing GHG Emissions Caps for Multinational Corporations: Key Issues and Design Decisions .................................................................................................. 7

III.A STRUCTURAL QUESTIONS AND OVERARCHING ISSUES ....................................... 8 III.A.1 FRAMEWORK: AN INTERNATIONAL AGREEMENT GOVERNING MNCS........................ 8 III.A.2 THE RELATIONSHIP BETWEEN CDM AND THE MNC CAP: DOES THE MNC CAP SUPPLANT OR

SUPPLEMENT CDM? ........................................................................................... 11 III.A.3 DEFINITION OF COVERED ENTITY: WHAT IS AN MNC?........................................... 16 III.B KEY DESIGN DECISIONS AND ISSUES ................................................................. 20 III.B.1 SYSTEM STRUCTURE: FIXED CAPS OR DYNAMIC TARGETS? ................................. 20 III.B.2 LEVEL OR STRINGENCY OF THE CAP OR TARGET .................................................. 22 III.B.3 DEFINITION OF COVERED ENTITY: OWNERSHIP..................................................... 22 III.B.4 DEFINITION OF COVERED ENTITY: UPSTREAM OR DOWNSTREAM APPROACH......... 23 III.B.5 COVERAGE BY GAS, SECTOR, AND/OR SOURCE CATEGORY ................................ 26 III.B.6 ALLOCATION OF CAP TO MNCS............................................................................ 26

IV. Conclusions ........................................................................................................ 28

References........................................................................................................................ 30

Appendix A: Overview of Financial Flows................................................................... 34

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I. Introduction

The Kyoto Protocol sets emission reduction goals for Annex I countries, which in practice translate to greenhouse gas reduction requirements for industrial companies and electricity generators in those countries. Much discussion has focused on the fact that the Protocol does not require such emissions reductions in developing countries beyond those achieved voluntarily through the Clean Development Mechanism. Little discussion has focused on the emissions generated in developing countries by the operations of multinational corporations based in Annex I countries. While no comprehensive data exists on the magnitude of these emissions, they are undoubtedly significant as the volume of investment by those companies in developing countries is significant.

In the latter half of the 1990s, over $200 billion in financing flowed annually from industrialized countries to developing countries.1,2 This financing originated from several different sources, including official development assistance and multilateral financial institutions, as well as private sector capital and loans. Multinational corporations (MNCs), which are enterprises with headquarters in one country and branches or other enterprises in one or more other countries, were responsible for roughly half of the total flow. Thus, developed countries have a substantial financial —and potentially significant emissions—footprint in developing countries.

This paper explores a proposal to cap greenhouse gas (GHG) emissions from the developing country operations of MNCs headquartered in developed countries. The proposal is intended as a way to focus initial efforts to reduce emissions in developing countries on those sources that have a direct connection to investments from Annex I corporations and financial institutions. The MNC Cap proposal is designed to incrementally move such investments in a more climate-friendly direction, and to complement similar corporate emissions caps implemented by Annex I countries. The proposal is also intended to supplement—rather than replace—the CDM, and to be compatible with other proposals that are being explored in the context of structural changes to the Kyoto Protocol. The proposal builds on company-level efforts to develop internal emissions trading systems and on existing corporate accountability efforts. It also seeks to level the proverbial “playing field” for MNCs globally by establishing similar greenhouse gas control requirements for their operations in all countries, in the process blunting the argument by opponents that the Kyoto Protocol encourages “industrial flight” to developing countries by MNCs.

In the following section, data on the financial involvement of MNCs in developing countries and their potential emissions impact is discussed. In the next section, the paper identifies a framework for developing an MNC cap and presents several key design questions that surround the development of the cap. The paper explores options for the broad features of a cap on MNC emissions, and raises key issues that are likely to arise. Last section draws conclusions and identifies key analytical questions to be resolved.

1 Throughout this section, monetary units used will be US dollars, unless otherwise specified. 2 The data sources for this estimate are the same as for Figure 2 in Appendix A; FDI is adjusted to account for developed country financial flows, as indicated in footnote for Figure 1 in Appendix A.


II. Private Sector Financial Flows3

In the year 2000, approximately $220 billion of financing flowed into developing countries from various private and public sources in industrialized countries. This flow was equivalent to about 4 percent of the combined GDP of developing countries.4 As illustrated in Figure 1, nearly three-quarters of the total flow came from the private sector. Of this, financing from multinational corporations (MNCs), represented by foreign direct investment (FDI), comprised the majority. Private banks and private investors supplied the remainder of private sector financial flows.

An MNC consists of a parent enterprise and its foreign affiliates (see Box 1.), which are foreign enterprises in which the parent enterprise has a significant degree of ownership, and over which it can exercise effective management control. MNCs, by investing in, or loaning money to, affiliated enterprises, are a key source of private sector financing. In turn, foreign direct investment is a key indicator of the level and rate of financial involvement of MNCs overseas. FDI has three components: equity investment (capital), reinvested earnings, and short- and long-term loans. In contrast to other forms of international investment, FDI is made to establish—or on the basis of—a lasting interest in an enterprise in another country.

FDI tends to be concentrated both geographically and by income. As indicated in Table 1, by far the greatest portion of global FDI (coming both from industrialized and other developing countries) to developing countries went to Latin America and the Caribbean, followed by East Asia and the Pacific. Similarly, nearly all FDI flowed to middle income developing countries.

3 For additional information on the data presented in this section, see Appendix A. 4 According to World Bank (2002a), the combined gross domestic product (GDP) of developing countries in 2000 was about $6 trillion.

Box 1. What is a Multinational Corporation? The spread of international business via FDI has led to the creation of firms whose operations span national boundaries. Such firms may be called multinational enterprises (MNEs), multinational corporations (MNCs), transnational corporations (TNCs), and global corporations. The UN estimates that there are over 60,000 MNCs, with over 800,000 foreign affiliates around the globe.

Some analysts have attempted to differentiate among these terms, or at least among different types of enterprises. For example, one author distinguishes between multinational firms that hold and operate business in a number of nations from truly global firms that pursue a unified strategy with regard to these operations. Others argue that global firms are those without home nations, so that global corporations are global entities. To a large degree, however, these terms have been used interchangeably.

Sources: Graham (1996) and UNCTAD (2002a).

Figure 1. Financial flows to developing countries from industrialized countries, 2000 Source: Appendix A.

Foreign Direct Investment

49%

Other private 27%

Development Assistance

and Multilateral Institutions

24%


Table 1. Flows of FDI to Developing Countries, by Region and Income Classification, in 2000a

Regional Classification $millions Classification by Incomeb $millions Sub-Saharan Africa 6,676 Least developed countriesc 4,315 South Asia 3,093 Low incomed 6,836 Middle East and North America 1,209 Lower middle incomed 61,825 Latin America and Caribbean 75,088 Upper middle incomed 90,923 Europe and Central Asia 28,495 East Asia and Pacific 52,130 Notes: a. Includes FDI from all sources, both developed and developing countries. The World Bank (2002b) estimates that 1/3 of FDI originates in developing countries. b. Totals of two classifications do not exactly match, due to slight differences between the data sources. c. Included in low income classification. Based on United Nations classification (UNCTAD 2001). d. The World Bank classifies countries in terms of per capita Gross National Income (GNI). In 2000, per capita GNI in low-income economies was $755 or less; in lower middle-income economies between $756 and $2,955; and in upper middle income economies between $2,956 and $9,265.

Sources: Regional classification data from World Bank (2002b). Income classification data from World Bank (2002a).

The flow of FDI to developing countries is significant—both relative to GDP and relative to other sources of financing for domestic investment. As indicated in Table 2, over the past decade FDI has risen to more than four and a half times its level in 1991, while Official Development Assistance (ODA) declined by almost 20 percent during the decade. Gross Fixed Capital Formation (GFCF), which is a rough indication of the magnitude of total investment in a country, has been a relatively stable proportion of GDP for developing countries during that the

Table 2. Relative Importance of Foreign Flows in Developing Countries

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Billions of US dollars GDPa 4,141 4,250 4,391 4,708 5,272 5,841 6,140 5,853 5,646 6,103 GFCFb 904 958 1,016 1,119 1,261 1,394 1,455 1,376 1,297 1,398 FDIc 36 47 67 90 107 131 173 178 184 167 ODAd 50 46 42 48 46 40 36 39 42 41

Percent of GDP GFCFb 21.8 22.6 23.1 23.8 23.9 23.9 23.7 23.5 23.0 22.9 FDIc 0.9 1.1 1.5 1.9 2.0 2.2 2.8 3.0 3.3 2.7 ODAd 1.2 1.1 0.9 1.0 0.9 0.7 0.6 0.7 0.7 0.7 Notes: a. Gross Domestic Product (GDP) is roughly the sum of gross value added by all resident producers in the economy. b. Gross Fixed Capital Formation (GFCF) measures the total amount of investment in a country, and includes both domestic and foreign investment, both private and public. c. Foreign Direct Investment (FDI) includes financial investment flows from both developed and developing countries into developing countries. d. Official Development Assistance (ODA) includes concessional assistance (grants or loans with a grant component). It includes both bilateral and multilateral assistance. Note that, because of differing definitions between the World Bank and OECD, these data do not exactly match the data presented in Figure 1.

Sources: GDP from World Bank. FDI and ODA from World Bank (2002b).


same period.5 However, in line with its absolute growth, FDI has also risen as a potential source of investment funds for developing countries—climbing to over 10 percent of GFCF between 1997 and 2000. Although FDI declined in 2001 and 2002 (see Box 2.), it is still viewed as a significant source of funding for developing countries overall, particularly given declines over the past decade in development assistance. The magnitude of FDI in developing country economies suggests that FDI could be associated with a significant portion of emissions as well.

As a percentage of GDP, FDI equaled about 3 percent in 2000 for both middle-income countries and all developing countries taken together. In contrast, FDI amounted to less than one percent of GDP for low income countries, and about 2 percent of GDP for the poorer least developed countries (based on data from World Bank, 2002a). Official development assistance was less than 1 percent of GDP for developing countries overall. ODA was, however, a more significant source of financial flows than FDI for the low income and least developed countries—amounting

5 Ideally, we would want to compare FDI to a measure of domestic investment. Unfortunately, there is no readily available estimate of domestic investment. Hence, Table 1 reports aggregate investment (GFCF), in order to provide a rough indication of the relative importance of FDI in domestic investment.

Box 2. Long-term Trends in Financial Flows to Developing Countries

Data from the OECD indicates that FDI declined significantly in 2001 and 2002 from earlier levels. FDI tends to rise and fall with financial cycles, while ODA is a more stable source of foreign capital for development. ODA remains the dominant source of foreign investment in many of the poorest developing countries. In contrast, FDI is large relative to developing assistance in the relatively industrialized or medium income regions (i.e., Central and Latin America and Europe).

Total foreign investment flows to developing countries (1980-2002)

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50000

100000

150000

200000

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1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

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Other private flows

Direct investment

OOF

ODA

Definitions: Official Development Assistance (ODA): grants and loans to countries and territories on Part I of the DAC List of Air Recipients. Other Official Flows (OOF): transactions by the official sector that do not meet conditions for ODA or official aid. Direct Investment: investment made to acquire or add to a lasting interest in an enterprise. Other private flows: mainly reported holdings of equities issued by firms in aid recipient countries.

Note that the OECD data reported here are slightly different from the data reported elsewhere in this paper. Differences result, in part, from differences between the data sources in the identified recipient and origin (or donor) countries for different types of financial flows. The OECD estimates that about half of all FDI to developing countries comes from other developing countries.


to 2 percent and 6 percent of GDP respectively—and close to zero percent for middle income countries.6

How energy intensive are the activities financed by these FDI flows? Although most industrialized countries keep data on the activities of their MNCs, Germany and the United States report in more detail than most on the geographic and sectoral distribution of financial flows (Falzoni, 2000). The United States provides relatively detailed data on geographic destination and sectoral distribution of the gross product of majority-owned foreign affiliates (MOFAs) of US-based MNCs (see Table 3).7 MOFAs are affiliates in which the ownership interest of all US parents exceeds 50 percent.

A detailed look at the US data on “value added” for MOFAs suggests that a significant portion of the activity of foreign affiliates of US companies is in energy-intensive manufacturing or in other energy-related industries. Almost 40 percent of the value added is in these sectors, including energy intensive manufacturing sectors (such as basic chemicals, paper, and petroleum products), utilities (which includes fossil fuel electricity generation), and sectors that both emit greenhouse gases and have implications for energy consumption in the economy (such as oil and gas extraction and motor vehicle manufacturing).8 Excluding all but the energy-intensive manufacturing sectors brings the proportion down to about 11 percent.9

How different is this pattern across countries? Appendix A reports selected financial activity data for MNCs in Germany and the US, for several energy-intensive sectors: oil and gas extraction, food and beverages, pulp and paper, coal and petroleum products, chemicals, rubber and plastic, primary metals, utilities, and motor vehicle manufacturing.10 The data, which are aggregated across both developing and developed countries, suggests that the industries supported can vary considerably across countries where the parent enterprise is located. Motor vehicle manufacturing is significant for both the United States and Germany. Oil and Gas Extraction, which is the largest category for the United States, is less than one percent for Germany.

6 ODA includes bilateral assistance and concessional loans and grants from development banks and other multilateral institutions. ODA data for this calculation are from OECD (2003) and so do not exactly match those in Figure 1. GDP is taken from World Bank (2002a). 7 Gross product is defined as the “portion of the goods and services sold or added to inventory or fixed investment by a firm that reflects the production of the firm itself.” Often referred to as “value added,” gross product can be measured as gross output (sales or receipts and other operating income plus inventory change and work in progress) minus intermediate inputs (purchased goods and services) (Mataloni, 2002). 8 Not all activities contained within a given sector listed in the table A produce greenhouse gas emissions, and so the assessment may be an overstatement of the “footprint.” The table also does not include all energy consuming manufacturing sectors. For a discussion of energy intensive sectors, see EIA (2004), ATLAS (2004), and Price et al (1999). 9 Other sectors that are not indicated here can emit significant amounts of greenhouse gases other than CO2 from fossil fuel combustion. For example, semiconductor manufacturing produces PFCs and SF6, two potent greenhouse gases. For some countries, this may be a significant component of foreign investment. 10 Unfortunately for our purposes, the two countries report different types of indicators of MNC activity: among other data, Germany reports direct investment flows from MNCs to foreign affiliated enterprises, and the US reports plant and equipment purchases made by foreign affiliates. In addition, the two countries do not report the data by economic sector broken out by the recipient of the financing (developing or developed countries). Consequently, it is difficult to reliably determine from these data the sectoral investment flows from developed to developing countries, and the statements below should be viewed with caution.


Chemicals, however, which is the second largest category for Germany, is only between two and three percent for the United States.

Table 3. Gross Product of MOFA of US MNCs by Selected Sector and Region, in 2000a,b (US$millions)

Developing countries (excluding Eastern Europe)c Sector World

Total Africa Latin America

Asia & Pacific

Middle East Total Percentage of

All Industries Total Energy-Related Industries 213,022 9,533 24,348 15,355 3,932 57,503d 39%

Food 19,231 100 3,738 685 114 4,637 3% Textiles 3,304 (D) 722 (D) 13 735 0% Paper 9,667 (D) 1,405 1,173 (D) 2,578 2% Petroleum and coal productsd 45,172 10 1,217 (D) (*) 5,562d 4%

Basic chemicals 8,709 13 1,193 528 42 1,776 1% Plastics and rubber 8,837 136 1,602 730 76 2,544 2% Mineral productse 4,099 2 496 455 1 954 1% Primary metals 5,567 105 614 62 5 786 1% Oil and gas extraction 49,935 8,993 3,215 9,974 3,681 25,863 18% Utilities 11,046 -1 2,039 2,981 0 4,929 3% Motor vehicles and parts 47,445 175 8,107 2,400 0 10,682 7%

Total All Industries 606,626 13,785 68,238 57,830 7,564 147,417 100% Notes: a. Gross product is defined as the portion of the goods and services sold or added to inventory or fixed investment by a firm that reflects the production of the firm itself. b. Data are disaggregated by industry sector and country of the foreign affiliate (not of the parent enterprise). c. Data are not available to identify developing countries according to standard taxonomies. Data for developing countries have been approximated by subtracting Europe (including eastern Europe), Canada, Australia, and Japan from Regional and World data. d. Over three-quarters of the world gross product in this sector is not identified in the BEA data by country, in order to avoid disclosure of company specific data. For purposes of this table, the data have been imputed to the developing country total for this sector based on the proportions of reported sector data attributed to developing and developed countries. Developing country totals for this sector and for “total energy related industries” will therefore not equal sum of country data. e. Includes cement.

Source: BEA (2002).


III. Establishing GHG Emissions Caps for Multinational Corporations: Key Issues and Design Decisions

The proposal explored in this paper is a cap on GHG emissions resulting from the activities of enterprises that are affiliated with multinational corporations having headquarters, or parent enterprises, in industrialized countries. Key aspects of the proposal are summarized in Table 4.

Under this proposal, Annex I Parties sign on to an international agreement or treaty and agree on behalf of their MNCs to participate in the MNC cap system. Covered MNCs are subject to an emissions cap or carbon intensity target on affiliated enterprises and operations in developing countries. As in any trading system, the cap establishes the aggregate emissions level and MNCs would be required to hold allowances equal to their emissions in the commitment period. The aggregate emissions cap/target and the allocation of emission caps/targets to Parties and covered enterprises would be determined by negotiations among the Parties. For equity reasons, this MNC cap cannot exist in isolation, but must be accompanied by controls on operations of MNC parent enterprises in industrialized countries, and so depends on countries fulfilling their commitments under the Kyoto Protocol.11

The currency in the system would be tradable MNC allowances (here termed MNC Activity Units, or MAUs). Depending on how the system is structured, entities covered under the cap would either receive an allocation of MAUs, or be permitted to purchase MAUs in an auction. Ideally, the MAUs would be fully fungible with AAUs and other tradable instruments under the Kyoto Protocol. At a minimum, however, covered enterprises could meet their targets either by reducing emissions or by purchasing MAUs or other instruments under the Kyoto Protocol.

An international organization would administer the system. Participating industrialized country governments would provide data on MNCs headquartered in their countries to help identify affiliated enterprises in developing countries. Industrialized country governments could also assist in enforcement against non-compliant corporations. Developing country governments

11 The reluctance of the US and Australia to ratify the Kyoto Protocol could diminish the effectiveness of the MNC cap.

Table 4. Defining Features of a Cap on MNC Emissions

Design Feature Considerations

Role of international organization

Design, administer, verify, and enforce system

Role of industrialized country governments

Assist in providing data on corporations; possible role in enforcement

Role of developing country governments

Possible role providing data on affiliated enterprises and on-site verification

Environmental target Developed based on negotiation

Overall structure Fixed cap or dynamic target

Participants in the system Multinational corporations

Geographic scope: emissions covered

Affiliated enterprises located in developing countries

Basis for compliance Actual emissions and holdings of MAUs and other instruments

Relationship with other trading systems.

Open system. Ideally, MAUs fungible with Kyoto instruments


could provide additional information on affiliated enterprises located in their countries and assist with on-site verification of emissions and emission-reducing activities.

Beyond these general features, the MNC cap should be designed to enhance its benefits in moving investment in a climate friendly direction, while minimizing its negative impacts on investment flows and competitiveness. The general advantage of the MNC cap is that it extends the emissions responsibility of MNCs beyond industrialized countries, and caps a group of emissions not directly captured by the Kyoto Protocol.12 It also works to cap these emissions, rather than relying on voluntary reductions. The MNC cap may be implemented without significantly involving developing country governments, unless governments desire to be involved. However, as discussed below, the MNC cap has the potential to increase the operating costs of enterprises in developing countries and so reduce the flow of investment funds. In addition, the design of the cap should be structured to minimize the extent to which corporations can evade the cap by redefining corporate affiliations and relationships—a form of leakage that would erode the environmental benefits of the cap.

As with any emissions trading system, designing and implementing the system requires making a series of choices about how the system is designed. For the MNC cap, however, several of these decisions will determine the fundamental legal and political feasibility of the system. Section III.A below discusses fundamental structural questions and overarching issues. In addition to these fundamental considerations, designing an MNC cap requires making a number of critical decisions and further fleshing out the features of the system. As indicated in the table above, several options are possible for a number of the design parameters of the system. The design options for further developing the system are discussed in Section III.B below.

A number of evaluation criteria are implicit in the discussion that follows, foremost among which are: administrative, legal, and political feasibility, emissions coverage and environmental integrity, impacts on competitiveness, compatibility with existing systems, and cost-effectiveness of emission reductions.

III.A Structural Questions and Overarching Issues

The fundamental legal and political feasibility and viability of the system will be determined by several considerations. These fundamental structural questions and overarching issues, which have been divided into 3 categories: (1) the fundamental structure of the system to operate and enforce a cap for MNCs, (2) the relationship between CDM and projects and emissions covered by the MNC cap and impacts on developing countries of alternative design decisions, and (3) the possibility of “gaming” under the system and the need to minimize this possibility through the definition of the covered entity.

III.A.1 Framework: An International Agreement Governing MNCs

The basic premise underlying the emissions cap system is that industrialized nations participate in an international agreement. Under this agreement, industrialized nations commit parent enterprises (MNCs) within their borders to report and reduce emissions of greenhouse gases that 12 Emissions covered by the MNC cap would likely also fall within a carbon-intensity cap for a developing country as a whole, as has been discussed in negotiations regarding future commitment periods.


arise in connection with their affiliated enterprises in developing countries. The agreement could take the form of a formal treaty or protocol negotiated from an existing platform, such as the UNFCCC, OECD, or other organization, or a new platform that is created for the purpose of the agreement. The appropriate platform would likely depend on political will and on the appropriate country basis for the agreement—taking into account issues of coverage, competition, and responsibility for emissions.

Alternatively, the agreement could take the form of a bilateral or multilateral agreement (such as a “gentlemen’s agreement).13 Under such an agreement, for example, countries could agree to develop domestic schemes to cap MNCs’ overseas emissions, with trading allowed between and among the MNCs.14 Alternatively, if nations were unable to agree to cap MNC emissions, nations could agree (more weakly) to “encourage” MNCs to take a voluntary agreement approach under the potential threat of a mandatory governmental system.

The international bilateral or multilateral agreement approach has some advantages over the approach of a formal treaty. It is likely that an agreement could be developed and implemented more quickly than a treaty. The provisions of the agreement could be modified or the geographical scope extended over time (as needed) more easily than a treaty—to reflect changing targets, for example, or to modify the definition of covered MNC as loopholes or other issues are discovered. Either the treaty or the less formal agreement are preferred to a voluntary system among MNCs, in terms of the greater certainty that emissions would be reduced, and the more extensive emissions coverage that it would be possible to achieve.

Under either the formal treaty or gentlemen’s agreement, the cap system would rely on enforcement by developed nations against parent enterprises; the nations themselves would not be subject to sanctions for failures of the MNCs to reduce emissions (identifying the “home” country of MNCs is discussed in Section III.A.3 below). The identification of covered entities would begin with identifying MNCs and their headquarters in developed countries based on publicly available records, and using public reports and corporate records to identify affiliated entities located in developing countries.15

An international institution would be required to administer the agreement, including recordkeeping, emissions and report tracking, verification, and other functions. The institutional and enforcement mechanisms would depend on the platform under which the agreement is

13 One example of a “gentlemen’s agreement” is the OECD Arrangement on Guidelines for Officially Supported Export Credits. This agreement was developed within the OECD framework, and provides terms and conditions governing official support for exports of goods and services. It is not an OECD Act, although it receives the administrative support of the OECD Secretariat. Participants can withdraw from the Arrangement by notifying the other Participants in writing. 14 An alternative approach might be to have a system that caps domestic emissions from MNCs, but allows these emissions to be offset by emission reductions (measured relative to agreed-upon entity targets) in affiliated overseas enterprises. While similar to CDM, this system would allow for a more streamlined approach to determining additionality and measuring emission reductions, since reductions would be measured at the entity level subject to an agreed-upon target. However, the system would only provide net environmental benefits if the target was measurably below business-as-usual. 15 Identifying covered entities from the bottom-up—beginning with developing country records on entities and then identifying links between developing country entities and foreign entities—would be considerably more difficult and time-consuming, and might result in entities being missed.


negotiated. For example, if the platform is the UNFCCC, compliance and enforcement mechanisms of the UNFCCC (such as the Compliance Committee) could be modified to authorize enforcement against MNCs or their host developed country government. To the extent that verification is linked to enforcement, enforcement of MNC compliance would also be the responsibility of the industrialized country government. The role of developing countries would be limited to identifying affiliated enterprises if needed, and facilitating on-site verification of emissions.

A critical component of efforts to limit MNC emissions will be the development of accurate and comprehensive data on greenhouse gas emissions from MNCs. Thus, an important first step in this process would be to require all MNCs headquartered in Annex I countries to report their country-by-country greenhouse gas emissions, an activity that could be accomplished under UNFCCC jurisdiction over the next few years. These data would facilitate the process of negotiating MNC caps, which could take place in advance of 2012, and the start of the next budget period under the Kyoto Protocol.

An open trading system. Throughout this paper, it is assumed that the trading system for MNCs is open (i.e., allows trading with entities outside the MNC system). MNCs would have access to available allowances from other sources or sectors via the Kyoto Protocol or other international trading mechanisms that might arise. Open trading will improve the cost-effectiveness of the overall system, and provide MNCs with additional opportunities to buy or sell allowances, thereby reducing their costs of emissions control. For a system to be fully open, however, MNCs would need to be able not only to buy and use Kyoto instruments or tradable allowance s from other trading systems for compliance, but also to sell excess MAUs outside the MNC system. This would require that a new instrument (the MAU) be developed and accepted under the UNFCCC. This instrument would make greater demands on integrating the MNC cap with the UNFCCC system, in terms of compliance requirements, definitions, rules, and other requirements.

Potential legal issues. While examples exist of the types of international arrangements and agreements among nations described in this section, a number of legal issues would have to be examined and resolved to ensure that the framework is legally viable. One set of set of questions concerns authority over the activities of MNCs in developing countries: under what circumstances developed countries would choose to control enterprises’ overseas behavior, and what domestic laws would need to be passed, as well as whether such laws would be perceived—or would actually—infringe on developing country sovereignty. A second question is whether an international agreement would create any problems from the perspective of WTO violations. A final set of issues concerns enforcement and what types of sanctions, administrative and enforcement mechanisms, and institutions would be necessary, and the extent to which it would be possible to piggy-back on existing institutions, such as those associated with the UNFCCC.

Voluntary agreement among industry. An alternative to the proposed approach of a treaty or agreement among nations is an industry initiative wherein MNCs voluntarily sign a formal contract under which they commit to report and reduce their emissions in developing countries. The voluntary system could link the internal trading systems currently being developed by a number of corporations, such as BP, Shell, and PEMEX. While participation in the agreement


under this industry system would be voluntary, the agreement itself would involve a binding obligation on the part of MNCs, once they have opted in. The contract would specify any sanctions for non-compliance, as well as the administering authority. The agreement would represent a contractual relationship that could be enforced through national or international court systems, depending on the laws specified to apply by the contract and the process for arbitrating claims under the contract.

In the case of a voluntary industry agreement, developed countries would have only a small role (possibly limited to providing public records to be used in identifying parent and affiliated enterprises). The threat of moving to a full mandatory system would be critical to insuring the success of this approach, much as the success of the EU’s agreement with automakers on fuel economy rests on the threat of formal EU regulation. The role of developing countries could again be limited to identifying affiliated enterprises if needed, and facilitating enforcement.

The UNFCCC provides a legal basis for commitments by governments (signatories to the UNFCCC and Kyoto Protocol) but not companies; no current structure exists for corporations to be capped by an intergovernmental body (Arthur Andersen 2001). Thus, a new treaty (or amendment to the UNFCCC or Kyoto Protocol) will likely be needed to create a program of mandatory controls—through developing country governments—on MNC emissions in developing countries.

III.A.2 The Relationship between CDM and the MNC Cap: Does the MNC Cap Supplant or Supplement CDM?

The MNC cap encourages emission reductions in developing countries, and involves foreign investors (via the MNC relationship). If, however, an affiliated enterprise in the host country reduces emissions at the enterprise in order to meet the cap (or to free up MAUs for sale), the same emission reductions cannot also represent a CDM project and generate CERs. It is, thus, natural to ask whether the MNC cap merely represents a different labeling of CDM projects and, if not, how CDM and the MNC cap compare and interact. This section begins to explore the differential impacts of the MNC cap and CDM on the environment, development goals, and financial flows in different sectors and developing countries.

Compatibility with Kyoto Protocol

In general, the MNC cap is compatible with project-based CDM, as long as the two systems do not cover the same emissions; consequently, the MNC cap may complicate the operation of project-based CDM in some circumstances, and require new rules and procedures to ensure that the systems are distinct. Under the MNC cap, some of the enterprises that are affiliated with MNCs covered by the cap will undertake emission reductions to meet the cap. In some cases, these emission reductions will be generated by actions that would—in the absence of the MNC cap—have been undertaken under CDM to generate CERs for sale. Thus, it is likely that some actions that an entity would have taken to generate emissions reductions that could be certified as CERs will be transformed from CDM projects into emission reductions to meet the MNC cap. In order to maintain environmental integrity, these emission reductions cannot be used both as CERs and to meet the cap. Rules will therefore be required to prevent entities that are subject to


the cap from also generating CDM credits, at least for the sectors and gases that are subject to the cap.

The MNC cap is also generally compatible with proposals currently being made to supplement the requirements of the Kyoto Protocol, such as proposals wherein developing countries pledge to implement sustainable development policies and measures (known as SD-PAMs).16 As in the case of CDM, conflicts can in some circumstances arise. For example, some policies and measures (PAMs)—particularly those targeted at GHG reductions directly rather than sustainable development—may target the same entities as the MNC cap, and so create accounting issues. For example, technology standards or voluntary emission control agreement with industry may target the same emission reduction technologies as the MNCs would employ, making it difficult to define a baseline and so set appropriate caps for MNCs.17 Again, appropriate rules and procedures will need to be developed to prevent double counting of emission reductions.

Global Environmental Impacts and Cost-effectiveness

The primary advantage of the MNC cap is that it pushes investment from industrialized countries in a more climate-friendly direction. From a global perspective, the MNC cap should encourage reductions that are incremental to those achieved by Annex I countries and therefore will provide increased environmental benefits over the current Kyoto Protocol structure. The most compelling argument for the global environmental benefits of the MNC cap is that it puts a ceiling on emissions, and so provides measurable environmental benefits—emission reductions down to the level of the cap—with a high degree of certainty. In contrast, the CDM is a credit system, and so all CERs generated under CDM replace—rather than supplement—emission reductions that would have occurred in Annex I countries. Thus, the CDM does not reduce the global level of emissions, while the MNC cap does.

The extent to which the MNC cap achieves significant emission reductions will depend on how it is designed. A mandatory cap, such as the one described in this paper, is likely to achieve greater emission reductions than a voluntary program (such as a voluntary reduction program among MNCs). If properly designed, the MNC cap will be set more stringently than business as usual; thus the extent of emission reductions under the cap will depend on the stringency of the cap, which in turn will depend on the results of international negotiations regarding how the cap is set. In addition, the MNC cap will create an expanded market for CDM and other Kyoto instruments. The more restrictive the cap, the greater the market created not only for reductions in the capped sector, but also for additional purchases of surplus Kyoto instruments to meet the cap.

16 SD-PAMs is a pledge-based approach to developing country participation in reducing greenhouse gas emissions. The approach focuses on implementing policies for sustainable development, rather than setting emission targets. In contrast to policies and measures requirements for industrialized countries, SD-PAMs starts with the development objectives, and then examines how these priorities can be achieved more sustainably, and identifies synergies between sustainable development and mitigation of climate change (Winkler et al. 2002). 17 Particularly if PAMs in developing countries can be considered CDM projects, it will be important to ensure that one emission reduction not result in two tradable units; in this case, a CDM certified emission reduction (CER) and a tradable (excess) MAU. For a discussion of PAMs as CDM projects, see Hargrave (n.d.(b)).


Under the MNC cap, entities that must comply with the cap may choose either to reduce emissions or to purchase allowances or other instruments elsewhere on the market. Because the MNC cap is open to purchases of Kyoto instruments (and excess MAUs can also be sold on the global market), the global market price of emission reductions determines the cost-per-ton of emission reductions in the MNC system as well as globally. The impact of the MNC cap on this global price will depend on the cost of reducing MNCs’ overseas emissions relative to the Annex I price (for allowances and CERs). If MNCs are net sellers—implying that the cost of emission reductions made directly by MNCs to comply with the cap is less than the cost of emission reductions made elsewhere globally—then the global price of emission reductions will fall. If MNCs are net buyers in the global market, then the global price of emission reductions will be driven up.

The MNC cap may affect the cost-effectiveness of emissions control in other ways. In theory, at least a portion of the emission reductions occurring under the MNC cap could have occurred under CDM. However, the transaction costs of developing a creditable-CDM project and taking it through the approval process can be quite significant, although they may be lower for some forms of unilateral CDM (CDM Monitor 2003). Trading MAUs under the MNC cap will likely have lower transaction costs, in part because of ready access to information flows between parent and affiliated enterprises, and the lower monitoring and verification costs usually associated with entity-based (rather than project-based) compliance systems.18 To the extent that some emission reductions are easier to undertake and sell under the MNC cap than CDM, the cap may encourage some types of emission reducing activities that would not have occurred under CDM, and so improve the overall-cost-effectiveness of the global emission reductions.

Country-level Emission Reductions: MNC cap vs. CDM

The emission reductions that occur under the MNC cap—like CDM projects that include foreign involvement (such as bilateral or multilateral CDM)—can be a source of investment funds and technologies. While emission reduction projects that would have occurred under CDM will still occur under the MNC cap, the MNC cap may shift the emphasis of emission reduction projects in developing countries.19 The types of changes to the developing country economy and development path that occur—relative to a situation without the MNC cap but with CDM—depend in part on how the cap is designed. In some cases, some MNC emission reductions will be CDM projects re-labeled, and so the types of projects that occur under the MNC cap and CDM will be similar. However, the CDM and the MNC cap are likely to encourage different types of investment and emission reductions, to some extent in different sectors, for reasons given below.

First, the types of emission reducing activities undertaken by entities in an MNC cap may be different from those occurring under CDM. The majority CDM projects have either been forestry

18 At the same time, the MNC cap is associated with a new set of administrative functions and compliance determinations—that are not part of the systems set up for CDM and the other Kyoto instruments, which will partially offset the lower transaction costs. 19 Geographically, the distribution of emission reductions under the MNC cap (if it follows the distribution of FDI) may be similar to that of CDM: The distribution of CDM projects in recent years—particularly the under-representation of Africa and poorer countries of Asia—is consistent with the overall distribution of FDI flows (Lecocq and Capoor 2003).


related or large scale hydropower plants (UNIDO 2003), and have largely represented purchases of CERs by foreign investors, rather than inflows of foreign technology and financing.20 While the sectoral focus of CDM is likely to broaden over time, it is also likely that, under an MNC cap, a greater focus will occur on process and other changes that can occur within an enterprise, resulting in more investment and technology transfer between parent and affiliated enterprises than has thus far occurred under CDM—particularly in the sectors affected by the MNC cap.

In addition, emission reduction projects undertaken in affiliated enterprises may be viewed by the parent enterprise as more desirable than a venture to invest in, or purchase the CERs associated with, an unrelated CDM project. In particular, emission reductions within the MNC structure may be viewed as less risky, since the emission reduction is measured against an entity target (rather than project baseline), reporting and compliance determinations are within the control of the enterprise, the risks of non-performance (and consequent liability) may be better understood, and financial and other project risks will be more familiar and known to the parent enterprise.

Third, developing countries can exercise control over CDM projects via host country approval processes, in order to ensure that projects have desirable socioeconomic impacts and support the sustainable development goals of the host country. The default for the MNC cap system, however, will be the same constraints and governmental requirements under which FDI currently operates. Consequently, unless an effort is made to integrate host country concerns into the rules and requirements developed to support the MNC cap, these concerns may not be reflected to the same extent that they are in CDM.

Finally, some of the facilitating provisions that are being developed under CDM will not be available to MNC cap activities. For example, procedures to fast-track small-scale projects provide an advantage to energy efficiency and renewables projects, relative to larger projects in the context of CDM. Similarly, bundling of emission reduction projects can assist in overcoming transaction costs and other obstacles to small-scale CDM projects (Sutter 2001). Again, projects under the MNC cap may not have these types of benefits. However, trading avoids all the subjective elements of the CDM process and should dramatically lower transaction costs (described above) more than offsetting any of these facilitating provisions of the CDM. .

Potential Impacts on the Flow of Investment Funds into Developing Countries

In general, the MNC cap will improve the competitive position of domestic enterprises that do not have significant foreign involvement relative to enterprises that do. Domestic enterprises that have low levels of investment or ownership by parent enterprises in industrialized countries participating in the MNC cap will not have to make emission reductions and so will not have to undertake mitigation efforts that firms with foreign involvement do. Consequently, the MNC cap can be viewed as a means of reducing emissions in developing countries without imposing significant costs on the developing countries themselves; rather, the burden of reducing emissions is largely borne by parent enterprises in industrialized countries and by domestic enterprises that have significant levels of foreign ownership. However, the consumers of goods 20 Thus far, little direct foreign investment has been channeled into CDM; rather Annex B countries like the Netherlands and multilateral CDM funds (like the World Bank’s Prototype Carbon Fund) have been seeking to purchase generated CERs (Jahn et al. 2003).


or services produced by these enterprises could bear some of the costs to the extent that these can be passed on in product prices, and workers at the MNC enterprises in developing countries could feel some impacts as well.

While a cap on MNC emissions will increase investments in lower greenhouse gas-emitting technologies, it may also reduce the overall flow of FDI by making it less attractive. Thus, a potential concern is that an MNC cap can at the margin discourage the influx of capital into developing countries where the emission reductions are made in order to meet the cap, and so slow the development trajectory. At a minimum, efforts to meet the emission commitments of the MNC cap will increase the operating or capital costs of affiliated enterprises in developing countries, regardless of whether reductions are made in house, or CERs, AAUs, or other units are purchased. At the extreme, it will discourage financial investment in enterprises in some sectors of some countries, in order to escape the requirements of the cap.21

Any reduced flow of FDI will affect the countries that receive FDI now and that, therefore, would be subject to the MNC cap. Countries with energy intensive industries or industries emitting greenhouse gases will also be more affected. It is difficult to estimate the magnitude of the impact of the cap in reducing FDI. Not only does it depend on the stringency of the cap and on how it affects corporate decision making, but the magnitude of impact also depends on the extent to which business location and investment decisions depend—at the margin—on environmental regulations. This issue has been extensively debated in the “pollution havens” literature, which provides no strong empirical evidence that a desire for weaker environmental regulations is a significant determinant of industry location decisions (in contrast to the importance of labor and other production costs, tax structures, and other factors).22 Moreover, to the extent that there is an effect, it would tend to be offset by the MNC cap—which operates to equalize the greenhouse gas emission controls required of MNC in both developing and developed countries.

Finally, to the extent that the MNC cap can expand the market for CDM projects, it could have a beneficial effect on some countries, depending on the routes that CDM takes in the future. For example, some have proposed that unilateral CDM may provide benefits to countries that would be in a risk category too high for bilateral investment—including FDI (UNIDO 2003). A country with an unattractive investment climate still can create exportable services in the form of CERs; hence the CDM has the potential to create export revenues and to attract new investors (Michaelowa and Vöhringer 2001). On the other hand, some believe that unilateral CDM, by reducing the direct investment of foreign investors in CDM projects, would reduce the supply of new technology and funding to the country (CDM Monitor 2003). In contrast, in multilateral CDM, where investments flow through a centrally managed fund to projects in host countries, host countries are more likely to secure CDM projects akin to their development goals and to

21 The withdrawal of investment funds may in some cases meet the requirements necessary to escape the cap, but not actually represent a severed financial relationship; see discussion in III.A.3 on escaping the cap. 22 The literature on pollution havens is quite substantial but inconclusive on whether there is a “race to the bottom,” i.e., whether economic activity shifts to jurisdictions with less strict environmental regulations (see, for example, Brunnermeier and Levinson (2004) and Smarzynska and Wei (2001)). In addition, there is evidence suggesting that, some foreign firms in developing countries meet higher environmental standards than local firms (Jeucken 2001). One could argue that, if the MNC cap equalizes the playing field for foreign capital internationally, it neutralizes any incentives that firms have to seek “pollution havens.”


obtain a better deal in the financial arrangements than in the bilateral model. Further, the multilateral approach has the potential to include poorer host countries while shielding investors from individual project failure (UNIDO 2003).

If the cap significantly reduces aggregate FDI flows into the country—or causes facilities that are important to the local economy to be shut down—and the economy suffers, then even wholly domestically-owned industries could be hurt by the MNC cap. Because FDI—like bilateral and multilateral CDM—tends to go to wealthier and more stable developing countries, any negative impacts of the MNC cap in reducing financial flows will be concentrated on these countries. Impacts on a country’s economy may be greater if the MNC cap targets certain sectors—for example the production of fossil fuels (see discussion of an upstream/downstream system in Section III.B). To the extent that changes in FDI have the potential to be significant, disproportionate impacts on any individual country could be minimized by requiring that a minimum percentage of emission reductions be achieved in each country in which the MNC operates, or by otherwise limiting the extent to which one enterprise or one country might bear the burden of reductions. This approach is of course much less economically efficient but could be needed as a political compromise to insure support of developing countries that might be projected to face disproportionate reductions because of the lower relative marginal cost of reductions at operations in that country.

It is unlikely that an MNC cap would be set stringently enough to cause these types of serious dislocations overall. International negotiations on climate change thus far have been mindful of the potential for economic dislocations in setting the levels at which caps have been set for industrialized countries, and are even less likely to set stringent limits where impacts on developing countries may arise.

III.A.3 Definition of Covered Entity: What is an MNC?

The primary spirit and intent of this MNC proposal is to identify emissions that, while occurring in developing countries, effectively result from significant investment or other activities undertaken in developing countries by parent enterprises that originate in industrialized countries.23 Thus, the focus is on reducing the “emissions footprint” of industrialized countries in developing countries, at little or low cost to the developing country economy.

The definition used to identify covered entities should, therefore, balance several competing goals:

• Redirect FDI toward climate-friendly investments that are economically competitive • Generate high coverage of enterprises in which foreign interests are strong • Avoid penalizing developing country enterprises that do not have foreign involvement,

at least in the early phases of implementation24

23 As in all systems with caps, provisions would need to be made for accommodating new entrants to the system. 24 A secondary, or long term, focus of the MNC cap could be on large emitters—many of which are likely to be MNCs headquartered not only in industrialized but also in developed countries—in order to cast a broad net and so both maximize emissions coverage and minimize competitive distortions (as well as increase the political acceptability of the cap among industrialized country MNCs). Thus, an additional criterion that could be applied to the development of the definition is that it should avoid creating a strong competitive disadvantage for foreign-


• Minimize gaming behavior by enterprises to avoid the emissions cap—a form of “leakage” that erodes the environmental benefits of the cap

• Not discourage the influx of important foreign investment and capital into developing countries

• Provide for simplicity in identifying covered enterprises and in measuring and monitoring emissions, in order to facilitate negotiating a cap and administering a subsequent system

The definition used to identify entities that are covered under the MNC cap—both parent enterprises and affiliated enterprises in developing countries will be an important component of the system. First, it will determine the emissions coverage of the system—which sectors are affected, and how many enterprises. Second, it will be a critical component of any strategy to reduce efforts to escape the cap by redefining corporate relationships. This section begins to explore how definitions for covered parent and affiliated enterprises could be developed, and briefly discusses how contractual and organizational changes could enable MNC to avoid the cap.

Defining MNCs and Identifying Covered Enterprises

From the perspective of administrative feasibility, the ideal definition of MNC would be one that is commonly accepted, widely used, and consistently applied across countries. The advantage of using an established or widely-used definition is that enterprises and government agencies will be familiar with it (and may have consistent definitions), and it could be possible to identify covered entities by tapping into existing data bases or by beginning with existing reported information. Although these ideal circumstances do not occur, some comparability does exist in how MNCs are classified for administrative purposes, as discussed below.

based MNCs relative to large emitters in developing countries that are not related to foreign-based MNCs. This issue is put aside until Section III.B.

Box 3. Terms Relating to the MNC Proposal Multinational Corporations (MNCs) or Transnational Corporations (TNCs): incorporated or unincorporated enterprises comprising parent enterprises and their foreign affiliates.

Parent enterprise: an enterprise that controls assets of other entities in countries other than its home country, usually by owning a certain equity capital stake (typically 10 percent or more).

Foreign Affiliate: an incorporated or unincorporated enterprise in which an investor, who is resident in another economy, owns a stake that permits a lasting interest in the management of that enterprise.

Subsidiary: an incorporated enterprise in the host country in which another entity directly owns more than half of the shareholder’s voting power

Associate: an incorporated enterprise in the host country in which an investor owns a total of at least 10 percent, but not more than half, or the shareholders’ voting power.

Branch: a wholly or jointly owned unincorporated enterprise in the host country which is one of the following a permanent establishment, a unincorporated partnership or joint venture, land, structure and/or immovable equipment directly owned by a foreign resident, mobile equipment operating within the country for at least a year. Definitions in this box are taken from UNCTAD (2002b). See also Falsoni (2000).


One option is to begin with a common definition of an MNC that is based on ownership (UNCTAD, 2002):

Parent enterprise and affiliates where parent enterprise owns 10 percent or more of equity capital in developing country affiliate (ordinary shares or voting power for an incorporated enterprise and its equivalent for an unincorporated enterprise). Affiliates under this definition would include branches, associates, and subsidiaries.

This definition provides a start for identifying the parent enterprises of entities that are considered multi-national.25 Covered enterprises in the developing countries would then, at a minimum, include the affiliates—subsidiaries, branches, and associate enterprises—of the parent enterprise, as identified in official company records. A threshold could be established for the size of MNC entity that is included, by sales, employment, assets, or other measure.

Once parent enterprises have been identified, it may be possible to identify, from publicly available investor company corporate records, other developing country enterprises with which the parent entity has a significant relationship. Such relationships might include joint ventures between the parent company and a developing country enterprise, where the parent enterprise provides technical expertise, patent sharing, management control, or other skills, in lieu of or in addition to some equity capital. Long-term contractual relationships also indicate a strong interest and some degree of control over developing country enterprises by the parent enterprise. Such a contract might occur if for example, the parent enterprise outsources production and manufacturing, as occurs frequently in appliance manufacturing or the pharmaceuticals industry; the products are then marketed under the parent enterprise’s brand name.

As part of the definition of covered entity, it is important to include cut-offs or thresholds, below which entities would not be covered. For example, the 10 percent equity capital cutoff for an affiliate of an MNC is somewhat arbitrary and, while commonly used, is not the only cutoff used by various countries in data collection. 26 A higher percent cutoff would restrict the set of covered enterprises to those with a higher degree of foreign interest and control. However, the disadvantage of raising the threshold is that it could omit operations that depend significantly on foreign capital and investment and generate a significant portion of developing country emissions as well. Higher ownership thresholds may, nonetheless, capture a significant portion of emissions. In the United States, for example, in 1999 majority-owned foreign affiliates (MOFAs)—which are foreign affiliates in which the combined ownership of all US parents exceeds 50 percent—accounted for 84 percent of the employees, and 78 percent of the capital expenditures, of all foreign affiliates of US MNCs (Mataloni and Yorgason, 2002).

Rules and guidance for the MNC cap will need to recognize that enterprises in developing countries may be affiliated with multiple foreign enterprises. Specifically, administrative rules

25 The “home” country of a firm is the country in which the firm maintains its headquarters. In most cases, this is the same as the country in which the firm was founded. A small number of firms maintain headquarters in two or more nations—for example, the Royal Dutch/Shell group (Graham 1996). 26 As a guideline, the International Monetary Fund suggests that investments should account for at least 10 percent of voting stock to be counted as foreign direct investment. In practice, many countries set a higher threshold. The OECD has also published a definition (World Bank 2002a).


will be needed to apportion emission reductions (or plant closures) that affect more than one foreign enterprise. Compliance by corporations will be more difficult because ownership and control decisions will be split among multiple enterprises, which may have very different priorities (and face different emission constraints). Companies with less than full foreign ownership will create and face some similar problems in decision making. A similar problem—multiple owners of electricity generating facilities—has been successfully addressed in the US Sulfur Dioxide Emissions Trading program; emissions are allocated pro rata among owners, who then pick a “designated operator” empowered to make decisions on behalf of all. The situation in the US program is simplified by the fact that owners are all located in one country.

Other decisions will alter the enterprises that are included as well. If sales or other criteria are used, thresholds would need to be developed for these criteria. Similar thresholds would need to be developed for identifying joint ventures or contractual relationships that are covered.

The broader the definition of covered entities—i.e., the lower the threshold for foreign involvement in an enterprise—the more complex will be determining in practice which emissions should be included. For example, while arguably all the emissions associated with a branch operation are under the considerable control of the parent enterprise and so should be counted in determining compliance with a cap, a parent enterprise will have far less influence and financial stake in an enterprise where it has only 10 percent ownership, or where there are multiple owners. Thus, the parent enterprise could be required to cover a smaller portion of emissions in cases where ownership is smaller, thereby complicating the determination of compliance and other administration of the system. Such a sliding scale, however, would provide additional opportunities for gaming and changing corporate structures in order to escape the cap.

Finally, in addition to identifying size thresholds, methodological decisions will affect which entities are included. For example, even for the 10 percent equity thresholds, options exist for how to calculate the threshold, e.g., using current market value of firms (which may be difficult to calculate or identify) or the historical book value, based on past investment and capital flows, and a mechanism would need to be developed for measurement.

Opportunities for Restructuring to Avoid the MNC Cap

A critical concern in the MNC cap is that MNCs may seek to avoid the cap by changing corporate structures. For example, a parent enterprise could sell off an asset in a developing country, and then substitute a contractual relationship with the previously-affiliated enterprise. Alternatively, the MNC could avoid the cap by moving the headquarters for the parent enterprise to a country that does not participate in the MNC cap system. This type of gaming could be avoided by specifying that enterprises once in the system remain in the system regardless of ownership; but this approach could be difficult to enforce if ownership is wholly transferred to domestic entities over which industrialized country governments have no legal jurisdiction.

It will be critical to understand the extent to which restructuring to avoid the MNC cap is likely to occur, to understand how different types of definitions can be used to minimize gaming, and to explore other options that reduce avoidance behavior.


III.B Key Design Decisions and Issues

In addition to the fundamental considerations discussed in Section III.A, designing an MNC cap requires making a number of other critical decisions and further fleshing out the features of the system. Several options are possible for a number of the design parameters of the system. As with structural issues, many of these design decisions would be subject to negotiation among the Parties. The design options for further developing the system are discussed in separate subsections: (1) whether targets are fixed caps or dynamic targets, (2) the level or stringency of the cap or target, (3) geographic extent of the cap, (4) whether the system is upstream or downstream in focus, (5) coverage of gases and sectors, and (6) allocation of the caps or targets.

This section discusses these issues from the perspective of designing a cap on MNC emissions in developing countries. In each case, there is a large body of literature on the topic, in the broader context of emissions trading. This section does not review that literature in detail, but rather seeks to highlight key considerations that will arise specifically during the design of an MNC cap.

III.B.1 System Structure: Fixed Caps or Dynamic Targets?

The basic system is one of tradable allowances. Participating MNCs are required to hold allowances equal to the emissions from their affiliated enterprises in developing countries (or a proportion of those emissions). MNCs are initially allocated allowances, or another form of emission rights (as in a target), and can buy or sell these allowances or rights to and from other MNCs.27 Those MNCs that can reduce emissions easily will choose to reduce emissions and may be willing to sell unused allowances to other MNCs; those MNCs for whom emissions reductions are costly to make will choose to purchase allowances to cover emissions. Overall, the system meets its emissions goals, and compliance costs are reduced, relative to a situation where trading is not allowed, because those MNCs for which emissions control is cheapest reduce emissions more than MNCs for which emission reduction is costly.

Given this framework, a key decision in system design concerns the overall structure of the system. This overall structure will determine how aggregate emissions are limited, the type of obligations that MNCs take on, and the nature of the allowance that is traded. Options for the overall design of the cap or target include adopting a hard (i.e., fixed) cap on emissions from MNCs, or developing a dynamic emissions target.

In a hard cap system, aggregate emissions among all participants are limited at a negotiated amount, and this amount is allocated to participating MNCs with affiliated enterprises in developing countries according to a pre-determined algorithm. The fixed cap option is analogous to the hard emissions cap of the Kyoto Protocol, under which trading can occur across Annex I nations, as well as within countries that have established national emissions trading systems. A fixed cap can be a permanent ceiling on emissions, a cap for a specified number of years, such as a budget period, or a predetermined emissions path that rises or falls over time. For example, growth in emissions to allow for economic growth could be provided if the allowable emissions path is based on negotiated improvements in emissions intensity and projected growth rates in

27 The issue of openness, and trading with other instruments of the Kyoto Protocol, is discussed in a subsequent section.


GDP). In this case, the distinction between a fixed cap and a dynamic target (discussed below) begins to blur.

What makes a hard cap is that aggregate emissions under the system are fixed and known with certainty at the start of each year or period. The central authority issues allowances (termed MAUs)—each allowance representing a ton of greenhouse gas emissions—equal to the amount of the cap. The allowances are then allocated to individual MNCs, based on a negotiated formula. To be in compliance with the system, an MNC must hold allowances equal to the quantity of emissions of its foreign affiliates. Thus, MNCs can buy and sell allowances. While this discussion assumes that allowances are initially given free to MNCs, other allocation mechanisms are possible, including an auction.

An alternative structure is to base the system on targets, which are analogous to a binding credit system. The dynamic target option does not cap emissions a priori but allows emissions to fluctuate depending on the levels of other variables. In general, the intent is to allow emissions to grow along with (albeit at a slower rate than) actual economic growth (as measured ex post by, for example, value added, output, or another economic variable or combination of variables). Carbon- or emission-intensity targets or indexing approaches (which tie allowable emissions to economic growth by fixing the ratio over time between emissions and actual GDP or other measure of growth), and variants on these dynamic approaches, have been proposed as options for extending participation of developing countries in later commitment periods (Baumert et al., 1999; CCAP, 1998; Hargrave, n.d.(a); Frankel, 1999; Philibert and Pershing, 2001).28

In contrast to a hard cap, under a target system aggregate allowances (and therefore emissions) are not fixed and known at the start of a period. Rather, aggregate emissions in the system are determined directly by the treatment of individual MNCs. That is, rather than abiding by an emissions cap and allocation rules, Parties would negotiate the rules by which emissions targets are determined—for example, what output measure and emissions intensity factor should be used for each industry, and how these should change over time. MNCs targets would then be determined by these rules; MNCs that generated emissions below these targets would generate allowances that could be sold to MNCs that were unable to meet targets.

A fixed cap for MNCs has several advantages relative to a dynamic target. First, the fixed cap is simpler to define because it does not require developing appropriate measurement techniques or instituting review and evaluation procedures for output measures or developing time paths of emissions intensity factors for a series of individual industries. Second, because the cap is fixed, the environmental results over time are certain. Moreover, enterprises seeking to plan for the future face less uncertainty about future requirements. Third, a fixed cap is also conceptually compatible with international emissions trading and national trading systems developed by Annex I countries with commitments, thereby facilitating tracking and trading of the allowances in an analogous manner to AAU and entity-level allowance trading under the Kyoto Protocol.

At the same time, a fixed cap may be viewed by industry as more restrictive than a target that allows directly for growth and so may be more difficult politically to negotiate and implement. Moreover, determining a reasonable fixed emissions cap (or emissions path)—even for a few 28 A third option, which is not discussed in detail here, is to adopt a combined or dual target (which could either be fixed or dynamic)—one a selling target and one a buying target (Kim and Baumert 2002).


years—may be a difficult undertaking, because of the uncertainty associated with projecting future emission levels, or production levels of MNCs, in developing countries. This uncertainty stems from uncertainty about future economic growth, population, and technologies, to name only a few factors. Hence, economic impacts on affected enterprises may be higher under the cap than the dynamic target, if growth is higher than projected. Conversely, a cap will produce some “hot air” reductions (i.e., a surplus of allowances that would not exist but for a generous cap), if growth turns out to be lower than projected. Depending on its provisions for new entrants or firms, the rigidity of a fixed cap may also discourage some investment in developing country economies over time.

III.B.2 Level or Stringency of the Cap or Target

For individual MNCs, either a cap or target can be set stringently enough to achieve real reductions in emissions relative to business as usual. Either system can also be developed in a manner that fails to achieve real environmental benefits, i.e., is too lax. The stringency of the cap should also be less than or equal to the stringency of Annex I caps. Thus, the methodology for setting the cap or target must treat countries and companies fairly and equitably, while at the same time resulting in meaningful and real emission reductions.

The methodology for determining the cap or target may have to take into account a variety of factors that vary across countries where affiliates are located. Such factors include projected economic growth, stage of economic development, the availability of historical data, and the certainty with which emissions can be projected. The resources that can be devoted to participating in the trading system—by corporations, industrialized country governments, or a central authority—will affect the design of the system. Factors may also include differences in MNC industries across and within countries, including the energy-intensity of production, historical and projected emissions, and readily available control technologies, i.e., the cost of emission reductions.

Further, the stringency of the system will depend on whether the system is based on a fixed cap or a target. For a fixed cap, the level should be chosen to balance the potential for generating hot air (if the cap is too loose), against potential restrictions on economic growth and development (if the cap is too stringent). For a dynamic target, stringency is primarily a function of the level of emissions intensity or carbon intensity that is chosen, and how that declines over time. Stringency for a dynamic target may also depend on the way in which output is measured (or another proxy for economic growth or output that provides the basis for the target). Both an emissions cap and a dynamic target, if set too loosely can result in “hot air” reductions, or if overly stringent can restrict economic growth.

III.B.3 Definition of Covered Entity: Ownership

Beginning from the ownership definition given in Section III.A to identify parent enterprises (and their relevant activities in developing countries) casts a relatively broad net. By intent, the MNC cap excludes the emissions of developing country enterprises that have no, or only a minimal, relationship with a foreign enterprise and with foreign capital. Restricting the definition in this way; however, excludes three potentially important groups:


• Activities arising from developing country MNCs—i.e., MNCs that are state-owned, or that are headquartered, in developing countries

• Activities in developing countries associated with foreign firms that are not considered MNCs

• Activities in developing countries associated with foreign capital flows that are not enterprise-based, e.g., loans that come from foreign banks.

One option is to adopt a broad definition of MNCs and to include the first group in the definition of covered entities. Broadening the definition to include this group would create a level playing field for large MNCs, regardless of the location of their headquarters.29 Competing equity concerns could be addressed by including a size cut-off to ensure that the multitude of very small MNCs—whether in industrialized countries or based in developing countries—would not be adversely affected by the cap.

The second group—investments and relationships involving firms that are not strictly MNCs but are international in focus—will likely include smaller firms that do business without owing controlling interests in any developing country enterprise. It is unknown what percent of developing country emissions this group might account for, and what number of enterprises might be involved. From the perspective of administrative feasibility, it seems reasonable to exclude this group from coverage, at least initially. Excluding the third group seems clearly consistent with the intents of the MNC cap proposal, since it does not involve foreign interests or enterprises located in the developing country, but the general flow of capital.

Initially, it makes sense to restrict the MNC cap as described in this paper, both because of the “emissions footprint” argument made herein, but also to provide the basic structure of a system that is manageable in scope but could be expanded over time. Broader definitions would help to address difficult issues of leakage and behavior by firms to escape the cap. These firms—the second and third groups above—can be addressed by domestic policies in developing countries. Moreover, behavior by firms to avoid the cap (i.e., divesting themselves entirely of developing country affiliations) is unlikely to be sufficiently widespread as to cause leakage problems that overwhelm the system.

III.B.4 Definition of Covered Entity: Upstream or Downstream Approach

A key decision affecting coverage of affiliated enterprises will be whether to focus on upstream emitters (e.g., operations at or near the point of fossil fuel generation) or downstream emitters (emissions that occur closer to the point of consumption of fuel).30 In the energy sector, for example, an upstream system might include petroleum exploration and refineries, whereas a downstream system would focus on electric utilities or other end users, such as large industrial boilers. While discussions (in other contexts) regarding upstream/downstream GHG emissions trading systems generally focus on CO2 emissions from combustion of fossil fuels, analogies exist for other gases and other source categories. 29 An examination of the top 100 carbon (fossil fuel) producers in the world, as listed in a report released by the NRDC (Lashof et al., 1999), suggests that almost a third of these companies are located in developing countries, and another 10 or so are in the newly independent states. Of these 40 or so companies, in 1997 all but two were state-owned or of mixed state and private ownership. 30 A related question will be whether to focus only on the activities of the affiliated foreign enterprise, or also to use the activities of the parent enterprise to screen out covered entities.


Key factors in choosing between upstream and downstream systems include:31

• Administrative feasibility—e.g., whether the numbers of entities is manageable (see text box) and data exist to identify and track covered entities

• Extent of emissions coverage within a sector and total emissions coverage • Ability to get coverage of different sectors (e.g., to go beyond the energy sector) • Compatibility with trading in the Kyoto Protocol and with national systems being

developed to facilitate trading under the Protocol • Feasibility of monitoring and verification • Consistency with international GHG accounting protocols • Incentives provided for emission reductions

In general, the upstream system has the benefit of being more administratively manageable (i.e., containing fewer entities) and achieving broad coverage of emissions related to fossil fuel combustion. Other sectors (e.g., industrial emissions) and other gases (such as methane) may be less amenable to an upstream approach. In the context of an MNC cap, however, an upstream approach may have difficulties that would not be encountered in a system of national caps. In particular, international GHG accounting procedures (and most proposed national trading systems as well as corporate trading systems) focus downstream at the point of emissions (i.e., for energy, at the point of combustion) (IPCC/OECD/IEA 1997). Thus, an upstream MNC cap would have to contain provisions to avoid double-counting emissions from fuels that are exported to (developed) countries covered by the Kyoto Protocol; the cap might also miss some emissions associated with foreign-owned MNC affiliate enterprises that are located in the

31 There is a large body of literature on the design of an emissions trading system. See websites of the OECD,

Box 4. How Many Participants Can Trade in a System? No set number of participants is optimal for a trading system. If too few companies trade, insufficient differences in control costs may reduce trading. Too many traders may make it difficult for buyers and sellers to find each other and consummate trades without centralized, automated assistance. Too large a number may also make the administrative costs of the system unmanageable.

Early simulation experiments (in the 1980s) suggested that a trading market can function with as few as 8 to 10 participants (USEPA, 2001), although a higher number—such as 30 or 40—is likely to make for a more liquid market. Two systems that are considered to have been successful in terms of trading have numbered between fewer than 100 participants to over 1000. In particular, the US Acid Rain Program (Title IV of the 1990 Clean Air Act Amendments) initially awarded allowances in 1995 to 61 large operating utilities (representing over 250 generating units) in its first year of operation (Ellerman et al.,1997), and the system now includes over 1000 participants (USEPA, 2003). The US Lead Credit Trading system (designed to reduce the cost of phasing out lead in gasoline) operated between 1982 and 1985 among all petroleum refineries and importers—about 200 to 300 refineries. Current efforts to design trading systems for greenhouse gas emissions in Europe and Countries with Economies in Transition (CEIT) have tended to include a few hundred participants initially, with the intent to expand to a larger number subsequently.

How many MNCs would be involved in emissions trading under the system described in this paper? A very rough estimate obtained by extrapolating from the limited data in this paper suggests that the number could range from 1,000 to perhaps 10,000. UNCTAD has estimated that there are some 60,000 MNCs worldwide. Assuming that approximately 2/3 of these are headquartered in developed countries, and that only about 10 to 25 percent of these have affiliates in developing countries, the number of potential participants falls to a few thousand, up to 10,000. Raising the threshold for ownership, and employing a size threshold, would likely reduce this number further. Thus, the number of participants might, realistically, be under 1,000, a manageable number. This estimate should be considered highly speculative.


developing country and are downstream consumers of energy that is not produced domestically but is imported.

Downstream systems generally are believed to result in lower coverage of emissions; for example, in the energy generation sector a national upstream system can typically cover virtually all CO2 emissions associated with fossil fuel combustion, while a downstream system usually focuses on large emitters and so captures a significant, but nonetheless smaller, portion of energy-related emissions. Similar results generally hold for other emissions related to fossil fuel combustion.32 For the transportation sector in particular, it can be very difficult to capture emissions using a fully downstream system (i.e., a system that focuses on vehicle owners). By focusing on the point of emission, however, downstream systems provide more direct incentives for emitters to take actions to reduce emissions and so have been preferred in the recent design of proposed GHG trading systems in countries in the European Union and elsewhere.

In the context of an MNC cap, a downstream system eliminates the difficulty associated with deciding how to account for domestic vs. foreign consumption of fuel. Moreover, because the MNC cap is not part of a broader trading system in developing countries, the conventional wisdom concerning the relative coverage under downstream and upstream systems may not be true. In particular, coverage under an upstream system will not generally be broader; rather, relative coverage of emissions associated with fossil fuel combustion under the two systems will depend on (a) the proportion of upstream fossil fuel production (or imports) attributable to covered MNCs, (b) the proportion of that production that is exported rather than consumed domestically, (c) the quantity of fuel that is imported (not by covered MNCs) and consumed by downstream MNCs. If, for example, fewer foreign MNCs are involved in upstream fuel production than downstream consumption, or if significant quantities of fuel are either exported or imported (and not imported by covered MNCs), a downstream system may achieve greater coverage—of the emissions associated with MNCs—than an upstream system.

Defining the covered entity may also pose difficulties—for either an upstream or downstream system—for achieving broad coverage, capturing large emitters, and being perceived as fair across firms. Consider first an upstream system. In many countries, the production of fossil fuel is dominated by MNCs that are state-owned. A recent study examining production data for coal, petroleum, and natural gas found that, in 1997, the 20 largest (upstream) producers of fossil fuels accounted for nearly 47 percent of the world’s carbon dioxide emissions from fossil fuel combustion (Lashof et al., 1999). Only 7 of the 20 were investor or privately owned; the remainder were state-owned enterprises and accounted for about 70 percent of carbon emissions for the group of 20.33 In turn, many of these enterprises allow foreign investment, or have joint ventures with foreign firms. Thus, it may be particularly important in an upstream system to carefully and broadly define foreign interests in a firm, or to widen the definition to cover all MNCs, including those that are not headquartered in industrialized countries. Analogous concerns could also arise for a system that focuses further downstream.

CCAP, PEW foundation, Resources for the Future, and UNCTAD, as well as a large body of academic literature. 32 The same is not necessarily true of other sectors, such as agriculture—where it may be difficult to define upstream approaches that are analogous to the approach for covering emissions from combustion of fossil fuels. 33 The data for the study are several years old. As privatization gains momentum, an increasing number of MNCs may become private but remain headquartered in the host country.


On balance, a downstream system will be preferred to an upstream system for the MNC cap. As alluded to above, an upstream system that focuses on extractive industries or oil refineries will increase fossil fuel prices to all consumers in the domestic economy—and so affect both wholly-domestic and foreign-owned enterprises that consume fuel. Thus, our goal of trying to minimize the impact of this policy on developing country consumers and companies will be much harder to achieve with an upstream system.

III.B.5 Coverage By Gas, Sector, And/Or Source Category

Part of the decision of whether a system should be upstream or downstream relies on (a) which gases (carbon dioxide, methane, nitrous oxide, or other GHGs) are included in the system, (b) which economic and GHG producing sectors (such as electricity production, industry, transportation, or agriculture) are covered, and (c) which source categories (e.g., within transportation, which mobile sources) are included. A related decision is whether to include all enterprises within a given producing sector or how to define cutoffs based on size or other criteria.

A critical issue will be the treatment of land use, land use change, and forestry under the system. Given the extensive debate about sinks in the Kyoto Protocol, as well as the economic importance of the timber industry in many countries, the treatment of LULUCF projects in the MNC cap could have far-reaching implications.

The feasibility of implementation (the size and manageability of the system as well as the feasibility of measurement and monitoring emissions and determining compliance is an important considerations in defining coverage for the system. Equally important are the environmental benefits (i.e., level of emissions coverage and the feasibility of emissions reductions in a given sector). Cost-effectiveness of control, competitiveness implications, and equity and fairness will all be important. For a variety of reasons, it may make sense to begin initially with one gas and sector (e.g. CO2 and energy). Such a system could be expanded over time and other sectors or gases phased in. Alternatively, separate caps for different sectors or gases could be developed.

III.B.6 Allocation of Cap to MNCs

If an aggregate cap is determined for the MNC system or for nations that are party to the system, allowances will have to be distributed initially to covered enterprises.34 Two primary methods are available: auctioning (letting covered entities—or other entities—bid to purchase the allowances) and free distribution (giving the allowances to covered entities based on a formula). The two mechanisms can also be combined; for example, allowances can be held back from the auction for sale to excess emitters, for new entrants, or as a buffer.35

Whether auction or free distribution, the question of ownership of the allowances—and who pays for the additional allowances needed for compliance, or receives the revenue from sales of

34 A similar set of methodological issues—also with cost and equity implications—surrounds the development of targets for an MNCs system. 35 The appropriate method of allocation may also have equity implications if it differs from methods used in Annex I countries that employ trading systems for domestic firms.


unused allowances—will arise. These issues will be thorny to resolve in the situation where there are multiple foreign enterprises involved in a developing country enterprise.

Once emissions are capped, allowances have monetary value. A key difference between the two methods for distributing allowances, therefore, is who initially benefits from the monetary value of an allowance under the cap. One advantage of the auction approach is that it generates revenues that can be used in any of a variety of ways, including financing projects and policies to support sustainable development and/or further reductions in GHG emissions, or to reduce tax distortions in the economy.36 However, what to do with the revenue will be a difficult decision; i.e., whether it is returned to the governments of the countries of the parent enterprise, redistributed to participating enterprises (parent or affiliated), used for administrative expenses, or given to developing country governments to support other emission reduction policies.

An auction—whether for initial distribution or over time—automatically and efficiently distributes the allowances to those entities to which the allowances are most valuable. Thus, the auction obviates the need for determining equitable formulas for distributing allowances to covered entities based on a metric such as historical or annual inputs, outputs, or emissions, as is required under the alternative allocation method.

At the same time, the auction system creates an additional burden on regulated entities that must purchase all allowances in addition to incurring the cost of reducing emissions to comply with allowance holdings. The auction method will, therefore, be less attractive to MNCs and so may generate less political support than free distribution of allowances, which gives the property rights (and monetary value) of the allowances directly to the companies. An option is to combine free distribution with an auction: a targeted compensation scheme that distributions a portion of allowances (free) to the most affected industries can partially compensate these entities for their losses while retaining most of the revenue benefits of auction.

Mechanisms for allocating allowances will also need to take into account entry and exit by firms, mergers and acquisitions, and other conditions that change the universe of covered entities. Auctioning allowances provides a more level playing field for new entrants into the market relative to existing entities. Further, both approaches—auctioning or free distribution—will need mechanisms for allocating allowances over time as well as initially; for example, an initial auction could be combined with distributed allowances in subsequent years.

36 Analyses of auctions for developed countries focus on the economic efficiency aspects of revenue recycling—the benefits of using the revenues to reduce distortionary taxes, or to correct market failures. Revenues can also be returned to the community to help defray the cost of emission reducing technologies. See, for example, Smith and Ross (2002), prepared for CCAP, and Crampton and Kerr (1998).


IV. Conclusions

Each year, tens of billions of dollars of investment flows into developing countries from industrialized countries, creating a financial (and potentially emissions) footprint of sizable proportions. These financial flows represent a largely unexplored avenue for changing the emissions trajectory in developing countries. This paper presents a proposal that begins to move a portion of these flows in a more climate-friendly direction. The proposal uses a tradable allowance system to cap emissions associated with the operations of enterprises in developing countries that are affiliated with MNCs with a parent enterprise in a developed country. The proposal works by changing the climate implications of investment flows that are already occurring in a variety of energy-intensive economic sectors.

This approach has the advantage of focusing on the emission reduction potential of enterprises in developing countries that rely on financial resources from developed countries and have controlling interests from developed countries, rather than focusing on the emissions of domestically-owned enterprises. It also works to cap the emissions of these affiliated enterprises, rather than relying entirely on the credit system of CDM or a voluntary system among MNCs. The MNC cap may also be implemented without significantly involving developing country governments, unless governments choose to be involved. In addition, it is compatible with current proposals to supplement the requirements of the Kyoto Protocol, and the system complements and builds on company-level efforts to develop internal emissions trading systems and build capacity in greenhouse gas accounting and related issues. Ideally, the instrument developed for trading under the MNC emissions cap should be conceptually compatible with the instruments under Kyoto and those being developed for country-level greenhouse gas trading systems.

The proposed MNC cap should be viewed not only as a cap proposal covering a portion of emissions in developing countries, but also as a way to address the perception of “manufacturing flight” to developing countries resulting from the exemption of developing countries from caps under the Kyoto Protocol. By leveling the greenhouse gas emission control requirements across parent and affiliated enterprises, the MNC cap helps to neutralize any incentives that might be created for the capital of MNCs located in Annex I countries that face emission limits to migrate to developing countries. In addition, the proposal presents an opportunity to generate better data on these emission sources, and to build awareness and capacity--in both mid-level management of MNCs and developing country governments—of the size of emissions associated with financial flows from industrialized countries and opportunities to reduce these emissions.

Political will on the part of industrialized countries and their MNCs will clearly be critical to moving this proposal forward. Several important issues would need to be resolved—at the level of the COP or another high level group—to develop an administratively and legally viable proposal. An agreement among nations to cap MNC emissions in developing countries could take several forms—ranging from a new protocol or treaty to a less formal bilateral or multilateral agreement. In turn, the nature of any agreement could also vary in stringency, from a commitment to cap emissions based on MNCs that are headquartered in their countries, to a promise to encourage MNCs to participate in an industry initiative to voluntarily cap and trade emissions.


Thus, the basic legal framework and entity for negotiating and enforcing an agreement with MNCs, must be resolved, as must a series of politically difficult issues, including the stringency of the target and allocations of allowances. An overly stringent target could have ramifications for the competitiveness of covered MNCs, as well as for the flow of investment money into developing countries. It is unlikely, however, that an MNC cap would be set stringently enough to cause these types of serious dislocations overall. International negotiations on climate change thus far have been mindful of the potential for economic dislocations in setting the levels at which caps have been set for industrialized countries, and are even less likely to set stringent limits where impacts on developing countries are concerned. Another important legal issue to address will be how to ensure the maximum openness of the system, insofar as the system will involve a new tradable instrument not already accepted under the Kyoto Protocol.

A number of important design decisions will determine the environmental effectiveness and cost of the system. One analytically difficult decision is how to define the covered entities—the participants—in the system clearly in order to provide for broad emissions without imposing high transactions cost for participants and administrators.. Additional thought will be required to devise a definition that minimizes the extent to which potential participants can redefine themselves legally or otherwise and so escape the cap. The point of coverage for the system—whether upstream or downstream—will also be important not only to the extent of coverage of MNC emissions and the feasibility of the system, but potentially also to its compatibility with other emissions trading systems and to its competitiveness implications. In a downstream system, it may be necessary to begin with a more narrowly circumscribed system (i.e., fewer sectors) in order to keep the number of participants to an easily manageable number and test out the system’s design principles. These and other issues will be critical to resolve as this proposal moves forward.


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Jahn, M, A Michaelowa, S Raubenheimer, and H Liptow. 2003. Climate Protection Programme: Unilateral CDM—Chances and Pitfalls. Published by Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH, Division 44–Environment and Infrastructure. November.

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Appendix A: Overview of Financial Flows

Each year, around $200 billion in financing flow from industrialized countries to developing countries.37 These financial flows come from a variety of sources, including the foreign direct investment (FDI) undertaken by multinational corporations (MNCs), loans and grants from multilateral development banks, such as the World Bank and various regional development banks (such as the Asian Development Bank), and bilateral aid between governments.38 Other private activities, such as commercial bank loans and purchases of bonds by foreign investors, as well as other multilateral organizations (such as the United Nations) and financial organizations (such as the International Finance Corporation) are also sources of financing.

Because the industrialized countries are a significant source of investment flows, loans, and other capital into developing countries, they—largely unintentionally—influence the greenhouse gas (GHG) emissions intensity of energy development, of transportation, and of industry in developing countries. Thus, these flows represent not only a “financial footprint” of industrialized countries in developing countries, but also a GHG “emissions footprint” that is of sizable proportions. These flows represent an unexplored potential tool for changing the current technology trajectory of developing countries and moving it in more climate-friendly direction.

This appendix presents data on overall financial flows and the investment flows associated with multinational corporations. These corporations—with parent firms numbering over 60,000 in both developed and developing countries—can exercise varying degrees of influence over nearly ten times as many affiliated companies in foreign countries, many of which are engaged in energy-intensive activities and so may produce significant quantities of greenhouse gas emissions. The first section in this appendix looks at overall sources of financing, followed by a section focusing on FDI, and then a discussion of energy intensity and the sectors influenced by these financial flows.

37 Throughout this appendix, monetary units used will be US dollars, unless otherwise specified. 38 FDI represents a net inflow of investment from MNCs to enterprises (in other countries) in which the MNC owns a controlling share. FDI includes equity capital, reinvestment of earnings, loans, and other financing. The next section provides more detail on the components of private investment.

Figure 1. Financial Flows to Developing Countries from Industrialized Countries, 2000

Development Banks

6%

Other Multilateral Institutions

4%

FDI 43%

FDI covered by ECA

investment insurance

6%

International Finance Corp.

2%

Bilateral Aid12%

Other private 27%


A.I Focus on Multinational Corporations and Foreign Direct Investment In the year 2000, approximately $220 billion of financing flowed into developing countries from various private and public sources in industrialized countries—about 4 percent of the combined GDP of developing countries.39 Large companies or projects in developing or transition economies often use a mixture of debt and equity to finance their activities, and the private sector provides both (Ganzi et al. 1998).40 Multinational corporations, by investing in foreign enterprises with which they are affiliated, or by providing short- or long-term loans to these affiliates, are a key source of private investment and loans. Private banks and private investors provide additional private resources.

As illustrated in Figure 1, aggregate private sector flows from multinational corporations (foreign direct investment) and other sources (other private capital) accounted for about three-quarters of total financial flows into developing countries from developed countries. Of the remainder, bilateral government aid, including other development assistance (ODA), was the largest component and accounted for almost half, followed by the development banks and then by financing from other multilateral and financial institutions.41

Private sector capital flow comprises three broad components:42

• Foreign direct investment—represents financial flows from multinational corporations to affiliated enterprises in other economies. FDI has three components: equity investment (capital), reinvested earnings, and short- and long-term intercompany loans between parent firms and foreign affiliates. FDI, as distinguished from other forms of international investment, is made to establish a lasting interest in or effective management control over an enterprise in another country.

• Portfolio investment—includes portfolio equity flows (the sum of country funds, depository receipts, and direct purchases of shares by foreign investors) and portfolio debt flows (bond issues purchased by foreign investors). Portfolio investment, unlike foreign direct investment, does not imply that the investor has an “effective voice in management.”

• Bank and trade-related lending—covers commercial bank lending and other private credit.

39 According to World Bank (2002a), the combined gross domestic product (GDP) of developing countries in 2000 was about $6 trillion. 40 Debt transactions involve a loan, mortgage, bond, or other instrument that requires the borrower to repay the lender in full plus interest. Private debt flows into developing countries include commercial bank lending, bonds, and some other private credits. In a public equity transaction, the investor purchases a share of a company, for example in the form of stock, the value of which will vary over time. Possession of equity in a public company usually implies a degree of shareholder control, which can be exercised through shareholder resolutions and voting of proxies (Ganzi et al 1998). 41 Data sources for Figure 1 are as follows. Bilateral Aid, FDI, and other private sector flows come from World Bank (2002b), Tables 2.1 and 4.1. The same source (p. 40) estimates that 1/3 of FDI originates in developing countries, which figure is used to adjust the FDI data for Figure 1. Flows from multilateral development banks and other multilateral organizations come from OECD (2003), Table 17. IFC data from IFC (2000). 42 Definitions are from World Bank (2002a).


A.II Foreign Direct Investment Foreign direct investment is a key indicator of the level and rate of financial involvement of MNCs overseas.43 In turn, FDI has in recent years been a key component of the investment and capital flows from the international private sector into developing countries. Figure 2 reports total inflows to developing countries in the latter part of the 1990s—including private sector investment from other developing countries as well as from industrialized countries. As illustrated in Figure 2, FDI from all parent companies peaked in 1999 at over $180 billion and over 80 percent of total foreign private sector investment in developing countries. As illustrated in Figure 3, by far the greatest portion of FDI (in the year 2000) went to Latin American and the Caribbean, followed by East Asia and the Pacific.

The flow of FDI (about two-thirds of which comes from developed countries) to developing countries is significant—not only relative to GDP but also as a potential source of domestic investment funds. As indicated in Table 1, Gross Fixed Capital Formation (GFCF), which is a rough indication of the magnitude of total investment in a country, has been a relatively stable proportion of GDP for developing countries over the past decade.44 In contrast, Official Development Assistance (ODA) declined by almost 20 percent during the decade indicated, while FDI grew to more than four and one-half times its level in 1991. In line with its

43 Other indicators include FDI stock (rather than flows), sales, employment, and mergers and acquisitions. 44 Ideally, we would want to compare FDI to a measure of domestic investment. Unfortunately, there is no readily available estimate of domestic investment. Gross Domestic Savings (GDS), which is formally defined as “GDP less total consumption” and is a rough indication of the funds generated by domestic sources and available for investment, comes close. However, GDS may be used either to finance investment (capital formation) or to acquire financial assets, and it is extremely difficult to separate the two components (Ranawerra 2003). Hence, Table 1 reports aggregate investment, in order to provide a rough indication of the relative importance of FDI in domestic investment.

Figure 2. Net International Flows into Developing Countries,

1997- 2000 (billions of US$)

0

50

100

150

200

250

300

350

1997

1998

1999

2000

Billi

on U

S$

Foreign Direct Investment Other Private CapitalMultilateral Non-Concessional Multilateral ConcessionalBilateral Official Aid

Source: World Bank, Global Development Finance 2002 ; OECD, Development Co-operat ion Report 2002 (Stat ist ical Annex).

Figure 3. Flows of Private Investment by Type of Investment and Region in 2000 (billions of US$)

-50

0

50

100

150

200

FDI Portfo lioEquity

Bonds Bank andOther

Billi

on U

S$

Sub-Saharan AfricaSouth AsiaMiddle East and North AfricaLatin American and CaribbeanEurope and Central AsiaEast Asia and Pacif ic

rce: World Bank, Global Development Finance 2002


absolute growth, FDI has also risen as a potential source of investment funds for developing countries—climbing to over 10 percent of GFCF between 1997 and 2000. Other private investment has fluctuated up and down considerably over time (because of some components that respond dramatically to changes in exchange rates and other market conditions), but has the potential also to exceed ODA.45

FDI generally plays a more important role as a source of funding in middle income, than low income, developing countries. However, official development assistance will generally be a higher percentage of investment in lower income, than middle income, developing countries (EC 1999). Although FDI declined in 2001 and 2002, it is still viewed as a significant source of funding for developing countries overall, particularly given the declines over the past decade in official development assistance.

45 Other private investment is less reliable as a source of funds, having fallen below zero in 2001 and 2002.

Table 1. Relative Importance of Foreign Flows in Developing Countries

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Billions of US dollars GDPa 4,141 4,250 4,391 4,708 5,272 5,841 6,140 5,853 5,646 6,103 GFCFb 904 958 1,016 1,119 1,261 1,394 1,455 1,376 1,297 1,398 FDIc 36 47 67 90 107 131 173 178 184 167 Other Private 26 52 101 86 99 146 128 105 40 59 ODAd 50 46 42 48 46 40 36 39 42 41 Percent of GDP GFCFb 21.8 22.6 23.1 23.8 23.9 23.9 23.7 23.5 23.0 22.9 FDIc 0.9 1.1 1.5 1.9 2.0 2.2 2.8 3.0 3.3 2.7 Other private 0.6 1.2 2.3 1.8 1.9 2.5 2.1 1.8 0.7 1.0 ODAd 1.2 1.1 0.9 1.0 0.9 0.7 0.6 0.7 0.7 0.7 Percent of GFCF FDIc 3.9 4.9 6.6 8.0 8.5 9.4 11.9 13.0 14.2 11.9 Other private 2.9 5.4 9.9 7.7 7.9 10.4 8.8 7.6 3.1 4.2 Notes: a. Gross Domestic Product (GDP) is roughly the sum of gross value added by all resident producers in the economy. b. Gross Fixed Capital Formation (GFCF) measures the total amount of investment in a country, and includes both domestic and foreign investment, both private and public. c. Foreign Direct Investment (FDI) includes financial investment flows from both developed and developing countries into developing countries. d. Official Development Assistance (ODA) includes concessional assistance (grants or loans with a grant component). It includes both bilateral and multilateral assistance. Note that, because of differing definitions between the World Bank and OECD, these data do not exactly match the data presented in Figures 1 and 2.

Sources: World Bank (2002a, 2002b).


A.III Energy Intensity of Investment How energy intensive are the activities supported by foreign investment? Table 2 presents the world’s top 25 non-financial MNCs, ranked by foreign assets in 2001. This table suggests that a significant portion of investment occurs in enterprises that are directly or indirectly (as in the case of motor vehicle manufacturing) linked to greenhouse gas emissions.

No data on greenhouse gas emissions is directly available, but available financial data is indicative of the potential magnitude of emissions and the importance of energy and emissions-intensive sectors in MNC investment patterns. Most industrialized countries keep data on the activities of their MNCs. However, Germany and the United States report in more detail than most countries on the geographic and sectoral distribution of capital flows and stocks and other data (Falzoni 2000). While the representativeness of these data relative to other countries has not been established, the data present an interesting snapshot of financial flows. In Germany, for example, over 90 percent of total direct investment in 2000 went to foreign affiliates in developed countries. For the United States, in 1999, more than three-quarters of the gross product produced by foreign affiliates originated in Canada, Europe, Hong Kong, and Japan.

While a detailed breakdown by sector of flows to developing countries is unavailable for Germany, a breakdown by sector of investment flows aggregated across all countries is available. An analogous breakdown for capital expenditures is available for the United States.

Table 2. The World’s Top 25 Non-Financial MNCs, Ranked by Foreign Assets in 2001 (millions of dollars)

Assets Corporation Home economy Industry Foreign Total Vodafone United Kingdom Telecommunications 187,792 207,458 General Electric United States Electrical & electronic equipment 180,031 495,210 BP United Kingdom Petroleum explor./refin./distribution 111,207 141,158 Vivendi Universal France Diversified 91,120 123,156 Deutsche Telekom AG Germany Telecommunications 90,657 145,802 Exxonmobil Corporation United States Petroleum explor./refin./distribution 89,426 143,174 Ford Motor Company United States Motor vehicles 81,169 276,543 General Motors United States Motor vehicles 75,359 323,969 Royal Dutch/Shell Group United Kingdom/Netherlands Petroleum explor./refin./distribution 73,492 111,543 TotalFinaElf France Petroleum explor./refin./distribution 70,030 78,500 Suez France Electricity, gas, and water 69,345 79,280 Toyota Motor Corporation Japan Motor vehicles 68,400 144,793 Fiat Spa Italy Motor vehicles 48,749 89,264 Telefonica SA Spain Telecommunications 48,122 77,011 Volkswagen Group Germany Motor vehicles 47,480 92,250 Chevron Texaco Corp. United Sates Petroleum explor./refin./distribution 44,943 77,572 Hutchison Whampoa Ltd. Hong Kong, China Diversified 40,989 55,281 News Corporation Australia Media 35,650 40,007 Honda Motor Co. Ltd. Japan Motor vehicles 35,257 52,056 E.On Germany Electricity, gas, and water 33,090 87,755 Nestle SA Switzerland Food & beverages 33,065 55,821 RWE Group Germany Electricity, gas, and water 32,809 81,024 IBM United States Electrical & electronic equipment 32,800 88,313 ABB Switzerland Machinery and equipment 30,586 32,305 Unilever United Kingdom/ Netherlands Diversified 30,529 46,922 Source: UNCTAD 2003, Table 2.


Table 3 indicates these data from Germany and the United States for some energy-intensive sectors. 46

The data reported for these two countries are not directly comparable, but both are suggestive of trends. For Germany, percent of total direct investment flows (506 billion Euros) across all sectors is reported for 2000. These data indicate financial flows from MNCs to foreign affiliated enterprises, including both equity and loans. For the United States, percent of total capital expenditures by foreign affiliates ($145 billion) across all sectors is reported for 1999. These data indicate the types of plant and equipment purchases being made by foreign affiliates in these sectors. The data for these two countries are not intended to be a comprehensive look at all energy-intensive sectors, but rather to highlight a few energy-consuming sectors and give a sense of their magnitude and contribution to overall foreign investment. In addition, it is unclear how these data relate to the magnitude of greenhouse gas emissions, or the potential for cost-effective reductions.

Table 3 reports financial activity data for MNCs in Germany and the US, for selected energy-intensive sectors: oil and gas extraction, food and beverages, pulp and paper, coal and petroleum products, chemicals, rubber and plastic, primary metals, utilities, and motor vehicle manufacturing. The data suggest that perhaps one-fifth to two-fifths of the activity associated with affiliates of MNCs occurs in these energy-intensive sectors, implying that there could be significant potential for modifying the energy intensity of FDI flows—assuming that the sectoral pattern of investment and equipment purchases is the same in developing countries as it is in developed and developing countries combined, and if Germany and the US are representative of all FDI flows and activities by affiliated enterprises. Insofar as Germany and the US together 46 Unfortunately for our purposes, the two countries report different types of indicators of MNC activity: among other data, Germany reports direct investment flows from MNCs to foreign affiliated enterprises, and the US reports plant and equipment purchases made by foreign affiliates. In addition, the two countries do not report the data by economic sector broken out by the recipient of the financing (developing or developed countries). Consequently, it is difficult to reliably determine from these data the sectoral investment flows from developed to developing countries, and the statements below should be viewed with caution.

Table 3. MNCs and Foreign Affiliate Activity in Energy Intensive Sectors, Germany and United States (percent of total activity across all sectors)

Oil & Gas Extraction

Food & beverages

Pulp &

paper

Coal & petroleum products Chemicals

Rubber &

plastic Primary metals Utilities

Motor vehicles manuf.

Germanya 0.4 0.47 0.2 0.2 8.38 0.8 0.4 0.3 10.4 United Statesb 14.7 4.7 1.3 1.9 2.4 1.1 0.8 4.6 7.6 Notes: Definitions of these sector categories across Germany and the United States are not identical. For example, “food and beverages” does not include tobacco for Germany, but does for the United States. a. Data for Germany are for year 2000, and represent foreign direct investment flows from Germany to affiliated enterprises in all countries. b. Data for United States are for year 1999, and represent capital expenditures (expenditures made to acquire, add to, or improve property, plant, and equipment) made by foreign affiliates in all countries. Sources: Mataloni and Yorgason 2002 and Deutsche Bundesbank 2002.


comprise about one-fifth of worldwide FDI to developed countries, the data from these two countries suggest a clear relationship between MNCs and developing country greenhouse gas emissions worldwide.47

In addition, Table 3 suggests that the industries supported can vary considerably across countries, if the United States and Germany are representative. Motor vehicle manufacturing is significant for both the United States and Germany. Oil and Gas Extraction, which is the largest category for the United States, is less than one percent for Germany.48 Chemicals, however, which is the second largest category for Germany, is only between two and three percent for the United States. Note that other sectors that are not indicated here can emit significant amounts of greenhouse gases other than CO2 from fossil fuel combustion. For example, semiconductor manufacturing produces PFCs and SF6, two potent greenhouse gases. For some countries, this may be a significant component of foreign investment. Further, not all activities contained within a given sector listed in the table produce greenhouse gas emissions.

47 The estimate of one-fifth is approximate, calculated based on data from UNCTAD on total FDI inflows to developing countries (including Central/Eastern Europe) and on data from the US and from Germany indicating the total FDI outflows that go to developing countries from each country, respectively (Deutsche Bundesbank 2002). Note that because of differences in data and definitions, the magnitude of FDI flows in the UNCTAD data differs from that reported elsewhere in this paper based on World Bank sources. 48 Data in table 3 are for all foreign affiliates and not just those in developing countries. Germany also reports data for developing countries at a more aggregated sectoral level. The pattern across sectors does not vary greatly between developing and developed countries, at this more aggregated level, at least for the very general purposes of the discussion here.

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INTERNATIONAL for Multinational Corporationsan administratively manageable way that would eliminate any potential loopholes for MNCs that may attempt to avoid the cap by restructuring,