Market-based mechanisms for controlling global emissions of greenhouse gases : Possible reference bases for international agreements

liP--- E I N E M A N N .Vururd Rwnmr.v t o r i m . Vul. 10. No. 3. pp. I 7 Y - I Y I . I V Y 5

Elsevicr Scicncc Ltd Copyright 1 IY95 United Nations

Prinlcd in Great Enlain. All :lyhlr rcrcrwd n I 65 - O ~ J / Y 5 I 1n.w + 0.m 0 165-0203(95)0023-2

Market-based mechanisms for controlling global emissions of greenhouse gases

Possible reference bases for international agreements

Frederico Net0

Increasing worldwide concern crbout global warming has led to intensified international efforts to reihce emissions of greenhouse gases. The most important outcome of these effbrts is the United Nations Frumework Convention on Climute Change, which came into force in March 1994. Although its signatories are expected to draw up plans to curb greenhorise gas emissions, the Convention does not specify how these emissions shoiild be controlled Since market-based niechunisms for emissions control have been increasingly emphasized at both national and ititernational levels, this paper discusses both tlicir advantages over regulation and the main obstrrcles to their itnplementution. The ultimate aim of the paper is to propose possible baseline criteria f iw the formulation oJa global tradable permit system to control carbon dio.ri& emissions.

Increasing worldwide concern about two global environmental problems - stratospheric ozone depletion and climate change - has led to intensified international efforts to control the main sources of atmospheric pollution. Two major global agreements for the protection of the ozone layer have been in force since the late 1980s.' In contrast, the first global agreement to combat the threat of global warming - the United Nations Framework Conven- tion on Climate Change - only came into force in 1994. Its signatories are required to formulate plans for curbing greenhouse gas emissions but not necessarily to implement them as the Convention does not specify control mechanisms (see United Nations report A/AC.237/18). In fact, the implementation of this Convention will require concerted international efforts to find efficient and equitable mechanisms for controlling global emissions of greenhouse gases.

Political negotiation at the intergovernmental level will determinc the outcome of these efforts. Never- theless, the process will be helped if environmental

The author is Associate Economic Affairs Officer. United Nations. Department for Economic and Social Information and Policy Analysis (DESIPA).

'The Vienna Convention for the Protection of the Ozone Layer and the Montreal Protocol on Substances that Deplete the Ozone Layer came into force in 1988 and 1989 respectively.

economics can present clear policy alternatives that take account of equity/efficiency trade offs. The purpose of this working paper is threefold. First, i t examines the main market-based policy options for reducing greenhouse gas emissions with a view to focusing on their theoretical advantages over regulation at the global level. Second, it discusses the main obstacles to the introduction of these mechanisms at that level. Finally, i t proposes possible reference bases which attempt to overcome some of those obstacles and thus contribute to ongoing intergovernmental discussions on the implementation of the Convention on Climate Change.

The greenhouse effect and global warming The greenhouse effect is a natural process without which the earth's temperature would be about 33°C cooler (IPCC, 1991) and thus be unable to sustain life as we know it on the planet. The temperature of the earth's atmosphere is determined by a delicate balance between short-wave incoming radiation from the sun and outgoing radiation reflected from the warm surface of the earth. While the incoming short-wave radiation passes through the atmosphere almost unhindered, the outgoing long-wave radiation is partially absorbed by trace gases concen-

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Table 1 Concentration of main greenhouse gases affected by human activities

Carbon dioxide Methane Nitrous oxide CFC-1 I CFC-12 (ppmv)" (PPmv) (PPWh (PPW)" (PPW

Pre-industrial ( I 750-1 800) 280 0.8 288 0 0 Present day (1990) 353 I .72 310 280 484 Ratc of change (1800-1990) 26.0% I 15.0% 7.6% Annual rate of growth (1990) 1.8 0.015 0.8 9.5 , I 7

- -

(0.5%) (0.9%) (0.25Ya) (4.0%) (4.0%)

Parts per million by volume. bParts per billion by volume. 'Parts per trillion by volume. Source: Calculated by author, based on IPCC (1991).

trated in the atmosphere and then re-emitted back towards the surface of the earth. This latter phenom- enon is what causes the greenhouse effect. The main natural greenhouse gases are water vapour, carbon dioxide, methane, nitrous oxide and ozone.

Mounting worldwide concern about the greenhouse effect arises because the steadily rising concentration of greenhouse gases generated by human activities is increasingly preventing the escape of reflected radiation from the earth's atmosphere and is thus causing an overall increase in global temperature. This process of global warming may, in turn, be responsible for other serious meteorological phenomena, such as disruptions in patterns of preci- pitation, cloud cover, wind field and atmospheric prcssure. In addition, the resulting melting of polar ice and other land based glaciers could lcad to a significant rise in sea level and thus threaten human settlements in many coastal areas. Global warming could also affect national economies by disrupting farming practices, energy generation, transport and other vital economic activities. Even geopolitical tensions could arise from the negative impact of climate change on transboundary river flows (see Niemann and Strzepek, 1994) and thus on the international allocation of a good so essential to human existence as fresh water.

As Tuhk I shows, an alarming rise in emissions resulting from human activities is substantially increasing the atmospheric concentrations of several major greenhouse gases, such as carbon dioxide (CO,), methane (CH4), nitrous oxide (N20) and chlorofluorocarbons (CFCs). As Figzire I also shows, COz is by far the most important of these anthropogenic gases. Its atmospheric concentration has increased by at least 26% since the industrial revolution and is currently rising by about 0.5%, mainly as a result of fossil fuel combustion (IPCC, 199 I ) . The increasing atmospheric concentration of chlorofluorocarbons - which had never been present in the atmosphere before their invention in the 1930s - has been even more striking since the 1950s. Emissions of these gases are currently rising by no less than 4% per year. The annual concentration of methane is currently increasing by about 0.9"/0 and has more

Figure 1 the greenhouse effect from 1980 to 1990

Source: I PCC ( I99 I ).

Relative contribution of anthropogenic gases to

that doubled since pre-industrial times. The concentration of nitrous oxide has risen by almost 8% during the same period and is now increasing by about 0.25% per year.

According to the authoritative Intergovernmental Panel on Climate Change (IPCC), this continued pattern of anthropogenic greenhouse gas emissions will cause 'a rate of increase in global mean temperature during the next century of about 0.3"C per decade . . . [which] is greater than that seen over the past 10000 years' (IPCC, 1991). This, in turn, will result in 'a likely increase in global mean temperature of about 1°C above the present value by 2025 and 3°C before the end of the next century'. In addition, because of the resulting thermal expansion of the oceans and the melting of some land ice, global mean sea level is likely to rise by about 6 cm per decade over the next century. This will result in a total rise of about 35cm by 2050 and 65cm by the end of the next

'The magnitude of emissions and natural elimination of both methane and nitrous oxide are not well understood yet (see IPCC. 1991, 1992). They should thus be considered preliminary and subject to change.

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targets would have little impact on countries in which environmental standards are already high, in other countries, they might require the introduction of cleaner industrial processes and equipment (technological costs), or even lead to the reduction of output, closure of industrial plants and consequent GDP losses (macroeconomic costs). This implies that different countries have widely different marginal costs of abatcrnent for a variety of reasons, including the extent of past abatement efforts. Thus, if all countries were required to abate by equal proportional amounts, some countries could cut emissions to the required level at little cost, while others would incur severe technological and/or macroeconomic costs to achieve even small percentage reductions. Such arbitrary systems of abatement would be economically inefficient, not only because more cost-effective policy options for reducing emissions would be ignored, but also because some countries would become accommodated with lower levels of abatement than might otherwise be possible.

In contrast, when emissions trading is introduced to achieve a global abatement objective, in theory, the first units of abatement should occur in countries (or firms within these countries) with the lowest marginal costs of abatement. As will be shown below, this occurs because lower-marginal-cost countries have the greatest financial incentive to cut emissions. As a result, the use of economic instruments also minimizes the total cost of emissions control at the global levcl. While environmental regulation will continue to play an important role in future efforts to controi atmospheric pollution, there is an economic case for greater use of market-based mechanisms for emissions abatement, at both the national and global levels.

However, just as a free market economy that is economically efficient would exhibit no necessary tendency towards equality of earnings, the efficient level of abatement (in terms of both cost-effective- ness and the lowest level of emissions per unit of output) may not be equitable. There are several reasons for this. First, equity considerations ought to take account of past and current patterns of economic development and consumption. These patterns are often associated with very high levels of emissions and use of natural resources in certain countries, while providing material benefits to a relatively small part of the world population (UNCTAD, 1992). In addition, given the very different stages of development and income levels among countries, funds allocated by developing countries to pollution control rather than to investment for the expansion of future output and improved living standards would have a relatively higher cost in these countries than in industrialized ones.' Third, whereas the

century. The inadequate state of current scientific knowledge is rcsponsible for a certain degree of uncertainty about both the nature and the magnitude of global warming resulting from anthropogenic greenhouse gas emissions. None the less, i t is very worrying to note that such a leading international panel of respected scientists as the IPCC considers it likely that damaging effects of climate change can occur as early as the middle of the next century, unless significant changes occur to the current patterns of these anthropogenic eiiiissions.

Equity/efficiency trade offs There are two basic approaches to control anthropogenic greenhouse gas emissions:

a a strict command and control system of environmental regulation;

a the use of economic instruments that encourage emissions abatement.

The two approaches are not mutually exclusive but there is a question of what policy mix would be the most efficient and efficacious for abating emissions. A strong command and control system is often criti- cized for contributing to accommodation with regulated levels of emissions. I t also inhibits investment on research and innovation that could strengthen economic performance and competitiveness. While regulation can control most emissions efficaciously, it is usually expensive to administer and enforce. I t may not even be efficacious overall as it is often undermined by government incentives for economic activities which worsen atmospheric pollution, such a s energy subsidies for the use of fossil fuels.

I f we define economic efficiency (of pollution abatement) in terms of both the least-cost policies and the lowest level of emissions per unit of output, market-based mechanisms for emissions control are likely to be more efficient than government regulation. This is primarily because these instruments minimize the cost of emissions abatement and provide incentives to cut emissions even more than regulated targets. In addition, such instruments stimulate technological innovation (and thus competitiveness) and are less expensive to administer and enforce than government regulation. There is, in fact, substantial evidence to show that these instruments would promote emissions abatement more efficiently than regulation. For example, a recent review of major international models of emissions control suggests that global costs of emission reductions (measured as potential GDP losses) could be cut by up to 50% using emissions trading instead of imposing equal percentage reductions in emissions for all countries (see OECD, 1993).

The imposition of such equal percentage reductions would lead to different responses by country (and by firm within a given country). For example, while such

'In Pact. recent research on the relationship between CO2 emissions and per capita income points to a diminishing marginal propensity to emit C02 as economies develop (Holtz-Eakin and Selden. 1992). which suggests that developing countries should focus more on economic growth than on emissions abatement per sc.

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marginal cost of abatement tends to be lower in developing countries. these same countries will find that their totul costs of abatement are much higher than in many industrialized countries with stricter pollution controls and lower levels of emissions per un i t of output. In sum. while the benefits of emissions abatement would accrue globally, its costs would Fall uncvenly on different countries.

These possible conflicts of interest at the international level suggest that decisions on equity/efficiency trade offs will, in the final instance, be determined by political negotiations, even if they have a clear economic component. In fact, one of the main objectives of environmental economics should be to evaluate the various economic options for reducing greenhouse gas emissions. There are, in effect, three major alternative market-based instruments of emissions control: (1) external offsets; (2) emission taxes; and (3) emissions trading.4

International market-based instruments for emissions control One crucial characteristic common to such mechanisms is that they can provide both a major economic incentive to cut emissions and equitable resource transfers from industrialized to developing countries. In theory, negotiation on any of the three market- based instruments could separate the question of efficiency from that of equity and achieve both simulta- neously (see Grubb. 1992). However, while there is considerable theoretical indiciition of the potential advantages of market-based instruments over regulatory ones, there are several important obstacles to thc actual implementation of the former at the international level, as will be discussed below.

Extc'rrid i$jiet tiwchrm'isr ns The application of the offset concept at the international level would mean that ;I country could meet an agreed national emission target by financing the abatement of emissions in another country. As a result, total national emissions in the former subtracted by the amount of emissions 'saved' by that external investment would meet the target. Furthermore, i t might even be possible to increase emissions above the agreed national target in one country - for example, by investing in a new power plant - provided that funds were also allocated for introducing cleaner technologies in an existing power plant in another country. In this way, the resulting emission cuts in the latter would offset the emissions generated by the new power plant in the former country.

'Another important economic option for reducing emissions would be to cut energy subsidies. a discussion of which lies outside the scope of this article (see. for example. Larsen and Shah. 1992).

One of the main advantages of an external offset scheme is that i t can make emissions control both more efficient and flexible by allowing a country to fund abatement in another where i t would be cheaper and/or easier than to carry out the same abatement itself. Another important benefit is that i t contributes to control greenhouse gas emissions with no need for a complex global agreement. In this way, industrialized countries (or companies based in these countries) can agree to emission reduction targets without actually reducing economic output. At the same time, these countries can transfer resources to developing countries without involving the latter in complex international agreements.

Nevertheless, there are considerable obstacles to the introduction of an offset system at the international level. First, such schemes may involve foreign direct investments and ownership of assets by one country (or a foreign based multinational corpora- tion) in another, raising difficult questions about control of strategic natural resources or levels of acceptable profit repatriation. As Grubb (1992, p 19) points out, offset transfers might also make it difficult to determine the responsible party if, for instance, a project in one country somehow failed to offset the emissions generated by a new source in another country. In addition. the difficulty in comparing emissions from different sources of greenhouse gases would undermine many forms of external offset deals. For example. i t would be problematic to compare the amount of emissions 'saved' by an investment to reduce deforestation (a source of greenhouse gases) in a developing country with the amount of emissions generated by a different source (such as a new power plant) in an industrialized one.

I t is doubtful whether industrialized countries would agree to make significant transfers to developing countries for emission reductions. unless the latter also invested significantly in such reductions. At the company level, there might also be strong resistance to environmental transfers to other companies in other countries, on both financial and compe- titive grounds. This suggests that external offset schemes would basically involve intrafirm transac- tions - as the experience of offset programmes in California shows (see Dwyer. 1992; Hourcde and Baron, 1993). In any case, offset schemes are often aimed at the maintenance of current levels of anthropogenic greenhouse gas emissions, as opposed to the substantial reduction of such emissions that is now required to control global warming. In fact. i t is sometimes argued that offset mechanisms are best viewed as a platform on which to build a more effective market-based system for global emissions abatement. For example. Roland (1992) regards an offset mechanism as a short-term instrument towards the achievement of a 'long-term solution', that is, global emissions trading.

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would harm competitiveness and have serious industrial and social impacts as it might lead to the reloca- tion of various industries to other countries, particularly in the developing world where there has been little support for such a tax. Moreover, the reduced energy demand in industrialized countries would contribute to downward pressures on international energy prices and thus stimulate demand elsewhere. The resulting rise in C02 emissions in other countries might thus offset gains in the countries imposing the tax.

As strong unilateral action is unlikely in the fore- seeable future, attention has turned to international emission taxes. According to a comprehensive typology of environmental tax regimes formulated by Godard (1 993), there are two different purposes of an international tax. An international tax for financial purposes would be paid by national governments to finance an ad hoc international fund. The amount to be contributed by each country would be determined by some negotiated financial criterion such as, for example, ability to pay as defined by a percentage of GDP. There is no particular technical reason to link the assessment of the tax to either the purpose of the fund or a specific national counter- part as the tax could be paid directly ou t of the central budget. Several authors imply that the Global Environmental Facility could be a precursor of such an international tax regime (Godard, 1993; OECD, 1992a). While this tax would be transparent and simple to collect, there are serious questions about the possibility that the international redistribution of tax revenues ‘might deviate from accepted economic and environmental efficiency criteria’ (Godard, 1993. pp 61-62).

Another possible regime would be to implement an international emission tax for incentive purposes, that is, to encourage the reduction of global carbon emissions. Under this regime, the payment of the tax by national governments would also go to a central international fund to be redistributed among participating countries according to some negotiated rule. National governments would, however, be able to determine what domestic policies were most benefi- cial to reduce national emissions to an agreed level. This regime would contribute to reducing global emissions by encouraging countries to minimize the total cost of the tax (net amount to be paid.plus the cost of curbing emissions) regardless of the tax rate chosen and the rules governing the redistribution of tax revenues among countries.

However, a significant impact on industrial choices might require a particularly high carbon tax. All six global models of carbon emission abatement analysed by the OECD (1993b) indicate that, while early cuts in emissions would be inexpensive, significant emission reductions at later stages would require very high taxes. For example, cutting emissions in the USA by 45% by 2020 from baseline (1990) would require carbon taxes ranging from

fnternationd emission tci.yes

In a free market economy the price mechanism does not fully account for several external costs of produc- tive activities, such as congestion, noise and pollution. One of the main purposes of a tax system is to internalize these externalities and ensure that the full costs of production are reflected in the prices charged. In this way, even if a power plant emits greenhouse gases, i t can carry on producing so long as it properly compensates society for the damages. Taxes are an efficient and efficacious way of dealing with externalities as they often minimize the costs of pollution control. By contrast, the enforcement of restrictions on some unsocial activities is usually less efficient than environmental taxes because it may restrict an activity that, despite its negative externalities, still benefits the performer more than its restric- tion helps society. Moreover, such taxes tend to promote the development and use of less polluting (and often more efficient) technologies and to discou- rage wasteful consumption patterns.

According to United Nations’ estimates (UN/ DESIPA, I993a), over the past four decades, a four- fold increase in the consumption of fossil fuels (coal, gas and oil) has produced a corresponding increase in C 0 2 emissions. At present, industrialized countries are responsible for approximately 47% of annual carbon emissions into the atmosphere (one unit of C02 contains 3.664 units of carbon), while the developing countries account for 27% and countries with economies in transition for 26%. However, with rapid economic and population growth, carbon emissions are expected to grow more rapidly in developing countries than elsewhere. None the less, at the national level, the imposition of a tax on COz emissions resulting from fossil fuel combustion has only been proposed in industrialized countries, notably in the European Union and in North America.

In any case, even in these Countries, there are serious economic and sociopolitical obstacles to the introduction of national carbon taxes. For example, according to a recent UK government study (DTI, 1992), energy demand in the transport sector, which is expected to be the single largest source of COz emissions in many European Union countries by 2000, is very inelastic and thus the least responsive to a price rise.’ A carbon tax might also have significant macroeconomic costs, even if it was made fiscally neutral by lowering other taxes. A recent European Union report (EC, 1992) estimates that a proposed tax equivalent to US$10 dollars per barrel of oil could cut 0.07% off the Union real GDP growth every year during the first 13 years after its introduction. If this tax were enacted unilaterally, it

5See also Gregory er ul (1992). who estimate that a carbon tax equivalent to USflO per barrel of oil would have little impact on the rapid growth of emissions generated by the transport sector in the U K .

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USS200 to USS350 per tonne of carbon emissions, compared with current energy taxes of USS30 per tonne. At the global level, i t is estimated that such carbon taxes would raise hundreds of billions of dollars annually. Leaving aside the complex question of how these vast revenues might be redistributed internationally, one of the main obstacles to the introduction of such a tax is the opposition of powerful interest groups (particularly in the energy sector) in many industrialized and developing countries, not to mention several countries with economies in transition and oil producing countries.

Tradable emission permits Establishing a global tradable permit system would, first of all, require international negotiations to define a global emissions target. Emission permits would then be issued against this total, according to a negotiated agreement for their allocation among participating countries. Such a system would also require that total emissions be limited or that a ceiling be imposed on the number of permits issued, and that trade should not be allowed without permits so they would not lose their market value. If a country’s initial allocation were insufficient, i t would have to purchase permits from other countries in the market. As a result, there would be a strong incentive for participating countries to cut emissions either to minimize their expenditure on purchased permits or to maximize their revenue from selling them in the market. According to Grubb (1992), this could also become a market solution for the problem of capital or technological transfers to developing countries if, as a result of the initial allocation, they were to hold excess amounts of permits. A tradable permit system would thus promote greater energy efficiency and technological innovation.

Although a tradable permit system could be developed a s a final stage of an offset mechanism, there are some important distinctions between the two systems. Unlike emission permits, external offsets do not require an initial allocation as they can be created by investing either in the reduction of emissions in other countries or in greenhouse gas sink enhancements, such as reforestation or cleaner seas. On the other hand, as Hourcade and Baron (1993) note, external offsets require ‘highly sophisticated measurement and monitoring procedures that cannot be easily set up between countries characterized by highly uneven development and administrative organization levels’. By contrast, the monitoring of emissions trading would consist of measuring the total emissions generated by participating countries, rather than the amount expected to be ‘saved’ by specific offset investments in other countries. As Grubb (1992) points out, there is thus no need to estimate what emissions might have been in a hypothetical situation, only what such emissions are at present.

There are three crucial differences between a tradable permit system and an emission tax regime which would also favour the former, at least at the international level. First, while an emission tax is designed to regulate expenditures on emission control. permits ensure that a given emission control target is achieved irrespective of the costs involved. This is an important distinction because, from a global warming perspective, the main goal is to achieve substantial reductions in greenhouse gas emissions, as opposed to simply ‘making the polluter pay’ or raising tax revenues. Second, while a permit system involves the exchange of quantifiable targets which can be determined in advance, a major defi- ciency of a tax regime is that policy makers cannot know in advance the tax rate required to reduce global emissions by a specified amount. Third, whereas a tax regime necessarily involves monetary transfers, permits can be exchanged in other ways, such as through technological transfers, which are likely to be ‘politically more appealing’ (see Grubb, 1992; Rose, 1992).

Based on limited experience in the USA, it is also argued that tradable permits create flexible market incentives to reduce emissions efficiently and at low cost. For example, most recent estimates put the cost savings to be achieved by emissions trading under the 1990 US Clean Air Act at over USSIO billion (in comparison with existing regulatory approaches) during the first phase of the programme. This programme is probably the only genuine example of emissions trading to have materi- alized at the national level. I t is basically aimed at reducing sulphur dioxide emissions to half their 1980 level by 2000 (the end of the first phase of the programme). Its ultimate goal is to remove the acid rain that is destroying forests and watersheds in both the USA and Canada. Instead of compelling electric utilities - which are by far the largest sulphur dioxide polluters in the USA - to invest in a specific type of pollution technology, the US Environmental Protection Agency (EPA) defines emission standards and issues permits for allowable levels of pollution. Electric utilities can design their own programmes to comply with such standards. At the same time, trading of pollution permits is encouraged: if the utilities reduce emissions more than required, they can sell their surplus permits in the market.

The Clean Air Act thus motivates companies to invest in pollution reducing research and development, and particularly in more efficient new technologies that reduce emissions beyond legal requirements. By inducing the sale of excess permits in the market, such investments could become very profitable. While most utilities follow this route, some have decided to buy additional pollution permits in the market as they consider i t the lowest- cost compliance alternative in the medium run. This course of action may also lead to improved profit- ability and even cost savings passed on to consu-

.

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Table 2 Estimated reductions in human-made emissions of greenhouse gases required to stahilize their concentrations at 1WO levels

mers. In addition, environmentally conscious groups and companies can help to reduce atmospheric pollution by purchasing and removing pollution permits from the market. This could thus provide an efficient and flexible market-based solution to the difficult problcms of environmental protection and of how to price externalities, although there have been some technical problems with the open market for trading the permits.6

There are at least two major obstacles to overcome if this potentially successful national experience is to be repeated at the regional or global level. First, agreement must be reached on a satisfactory initial distribution of permits among countries, which would determine the distributional implications of the tradable permit system. This would probably pose the greatest obstacle to the implementation of such a system at the international level. Second, the administration and monitoring of global emissions trading must be carried out by an institution acceptable to all parties. These are not issues unique to a tradable permit system and would have to be settled by international negotiation. Furthermore, provided that agreement is reached on the distributional bases of the permit system, its monitoring might well be handled by an existing international organization.

Possible reference bases for international agreements Given the unsurmountable obstacles to the introduction of a global emissions tax, as well as the limitations of external offset mechanisms, emissions trading is increasingly seen as an attractive market-based option for controlling global greenhouse gas emissions. However, in view of the obstacles to its implementation at the global level, it is essential to identify baseline criteria that could aid ongoing intergovernmental discussions, particularly with regard to the initial allocation of permits. Among several possible criteria, there are at least four central principles to be considered:

0 the types of greenhouse gases involved; the industrial sources of such gases;

0 the possible economic and demographic bases for international allocation mechanisms;

0 national responsibilities with regard to cumulative emissions.

The comprehensive upprocick to emissions trading

Much of the recent discussion of emissions trading has been based on the advantages and drawbacks of a 'comprehensive approach' to emissions control

'Due to technical problems in the operation of the computerized exchnnge system developed by the EPA. many utilities have decided to trade permits by private contracts.

4.

Greenhouse gas Minimum reduction ("/a)

Carbon dioxide 60 Methane 15 Nitrous oxide 70 CFC-I I 70 CFC- I2 7s

Source: IPCC (1991).

(see, for example, Smith, 1993; Subak, 1993; Grubb, 1993; Swart, 1993). Strictly speaking, a comprehensive approach involves including sources and sinks (that is, ecosystems capable of absorbing greenhouse gas emissions, such as forests, and oceans) of all anthropogenic greenhouse gases into a 'weighted basket' defined in terms of their respec- tive radiative forcings.' As a comprehensive approach would encourage optimal trade offs between different greenhouse gas emissions (including both their sources and sinks), it is argued that i t would also promote the largest overall reduction in radiative forcing at the least possible cost. Furthermore, some analysts argue that a tradable permit system for emissions control could only be efficacious if all greenhouse gases were included (Smith, 1993). In fact, as Table 2 shows, considerable reductions in human-made emissions of most greenhouse gases are considered essential to stabi- lize their atmospheric concentration at 1990 levels. However, these recommendations are exclusively based on the scientific considerations of the IPCC. rather than on issues related. to the economic performance of a tradable permit system.

In fact, it can also be argued that ;I comprehensive approach is incompatible with any quantifiable control regime, such as emissions trading, given the inadequate state of current scientific knowledge concerning the exact magnitudes of sources and sinks of several greenhouse gases. For example, according to the IPCC (1991, p 20). emissions of mcthane arising from biomass burning may be uncertain by at least f 50%, and several other important sources of methane, such as wet rice agriculture and coal mining, have even higher rates of uncertainty. So little is currently known about the nitrous oxide cycle that high uncertainty about both its sources and sinks also precludes its inclusion in any quantifiable control system. Similarly, while i t is well known that the atmospheric concentration of ozone (another important greenhouse gas) is changing rapidly as a result of human activities, it is so difficult to quantify these changes that ozone is often included under 'other gases' in the IPCC calculations of the relative contribution of greenhouse gases

'According to the IPCC (1991). the term 'radiative forcing' refers to the increased net inflow of radiative energy (and thus heat) resulting from the atmospheric concentration ol' greenhouse gases.

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Table 3 The relative contribution to global warming of 1990 emissions of anthropogenic greenhouse gases over the nest 100 years

Greenhouse gases 1990 emissions Global warming potential Relative contribution

Cirhon dioxide 26 000 I 61.0 Mcthane 300 21 15.0 Nitrous oxide 6 290 4.0 Chlorolluorocarbons I I50&7300 11.5 Other gasesh - Various 8.5

(teragrams)” (100 year time horizon) (1990-2090) (%)

“One terigrim denotes ;I factor of 10”

Solrr,cc: I PCC ( I99 I ). Estimates of the relative contribution of other gases (including ozone) are highly model dependent and liable to future corrections.

to global warming. In addition, these problems are exacerbated by the fact that substantial reductions in the atmospheric concentration of ozone are caused by increased chlorofluorocarbon emissions.

At the present time, only emissions of C02 and chlorofluorocarbons can be monitored under a tradable permit system. Even so, while estimates of chlorofluorocarbon emissions are generally regarded as reasonably accurate. recent calculations imply that their overall radiative forcing may be smaller and more uncertain than previously estimated because their cooling effect through their depletion of stratospheric ozone partly offsets their direct global warming effects (see IPCC, 1992). In any case, it would be inappropriate (if not legally problematic) to include such gases in :i tradable permit system as this could lead to considerable interference with the implementation of the Montreal Protocol on Substances that Deplete the Ozone Layer.

These problems preclude the implementation of a comprehensive tradable permit system in the near future. They also suggest that international efforts should be focused on the reduction of CO, emissions. especially from the burning of fossil fuel, which accounts for approximately 80% of total anthropogenic CO? emissions and may be accurately estimated to within f 570.’ In fact, a s both Table 3 and Figtirc 2 clearly show, CO, emissions are likely to account by far for the largest share of all the anthropogenic emissions that will contribute to global warming over the next 100 years. Global emissions trading should, therefore, be primarily aimed at reducing industrial sources of CO, emissions - rather than emissions of all greenhouse gases - on the grounds of its greater feasibility (given the need for quantifiable controls) and even its efficacy (given the leading role of CO, emissions in the process of global warming). The main concern here is not to elaborate the mechanics of a hypothetical global market for tradable permits,’

COz emissions from deforestation and other land-use changes are estimdted to account for the other 20% of total anthropogenic emissions. They are usunlly only available for tropical countries and may bc: uncertain by at lenst SOU/. (IPCC, 1991). This high degree of uncertainty. together with the North-South gcopoliticnl implications. would probably preclude its inclusion in i~ globill tredihle system.

but to propose some basic criteria which may help ongoing intergovernmental negotiations.

Industrid soiirces of CO-, emissions In order to define some basic criteria for a global permit system, it is necessary first to consider the main industrial sources of global COz emissions: the burning of liquid, solid and gas fuels, as well as the manufacture of cement. Although a s much as 0.5 tonnes of COz is released for each tonne of cement produced, little can be done to reduce emissions through technological innovation in the near future. This precludes any significant reduction in emissions a s restrictions on cement output would lead to serious negative multiplier effects on employment and economic activity. Fortunately. a s Figiu-e 3 clearly shows, cement manufacturing accounts for only a small proportion of total CO, emissions from industrial processes.

The other three industrial sources of COI are ideal candidates for a global tradable permit scheme. first. because they account for the bulk of indiistrial emissions and second, because they iire substitutes. Given that oil and coal together account for approximately 80% of citrrent CO, emissions from the burning of fossil fuels (see Ttrble 4). i t is advisable to favour cleaner fuels. such as natural gas.’” when determining initial allocations of pcrmits. Such preference for gas is also justifiable on efficiency grounds a s the burning of cod releases twice a s much CO, a s the burning of natufid gas (for the same amount of energy produced), whereas oil combustion emits 1.5 times the amount of CO, released by natural gas combustion (CDIAC. 1993).

Econoinic trritl cluiiogrcrpliic critcvin ,/Or i i i~ l i i .~ t r id eriiissiorrs At present, industrial emissions of CO? - that is, all forms of fossil fuel burning and cement manufac-

‘For vxrious proposals ol’ possible miirkel architectures. including niech:inisnis to deal with possible striicttiral problems of ;I globnl triidable permit system. we UNCTAD (1993. OECD (1991b) and Hayes and Smith (1993). “’Although ;I simihr argument is often put forward by the drl’en- drrs 01‘ the ntlcleilr energy option. i t is surrounded by ii great deul of conlroversy on both 1inanci;ll ond sarety grounds.

I86

Conrrolling ertiissiuns of'grcwilioiise go.w.r: F Nim

Figure 2 Estimated contribution of anthropogenic gases to the enhanced greenhouse effect over the next 100 years (base year = 1990) Soltrce: IPCC (19YI).

turing - are estimated to account for over 80% of total anthropogenic COz emissions. A tradable permit system based on such industrial emissions could thus contribute to a substantial reduction of total CO-, emissions. In addition, a s these industrial emissions can be accurately estimated to within f 5 % , the monitoring of such emissions trading is both feasible and effective. Furthermore, such a system could achieve considerable reductions in global emissions by making initial allocations dependent on certain economic and demographic criteria which would target a relatively small group of industrialized and developing countries and economies in transition. As T d h 5 shows, the 30 countries with the highest emissions from industrial processcs in 1991 accounted for over 85% of total industrial emissions in the world.

By providing the ranking of these 30 countries according to emissions per uni t of GDP, Table 6 could be used a s a basis for the initial allocation of permits. For example, by allocating a relatively higher amount of permits to the most inefficient countries (that is, those with the highest emissions per uni t of GDP), global emissions trading would encourage these countries to cut down their emissions per output in order to sell the extra permits

I oooo

8000

6000

4000

2000

0 Oil Coal Gas Cement

Figure 3 Industrial source of global carbon dioxide emissions in 1991 (million tomes)

S ( J I ~ ~ C L * : CDIAC (1993).

in the market to countries which required them. This would ensure significant improvements in both global energy efficiency and global emissions per output, even if such an allocation of permits would be unfavourable to many industrialized countries. A similar (demographic) criterion could be based on Tlible 7, which ranks these 30 countries according to emissions per capita. A larger allocation of permits to countries with higher emissions per capita would, however, be unfavourable to many developing countries with large popula- tions and low emissions per capita (particularly the 10 developing countries at the bottom of the table).

Ciiniuhive emissions and the natriral debt criterion

Since current COl emissions can be easily quantified and are thus subject to effective control, they are the most evident measure of national responsibility with regard to global emissions. This measure, however, does not fully reflect national responsibility, as

Table 4 Industrial sources of global carbon dioxide emissions, 1951-91 (Mt)

Oil" (%) Coal (%) Gas (YO) Cement (YO) Total

1951 1843.0 (28.3) 4166.0 (64.0) 421.4 (6.5) 73.3 ( 1 . 1 ) 6503.6

1971 7452.6 (48.0) 5730.5 (36.9) 2029.9 ( I 3. I ) 307.8 (2.0) 15520.7 1981 8581.1 (45.7) 7042.2 (37.5) 2696.7 (14.4) 443.3 (2.4) 18763.3 1991 9749.9 (42.9) 858 I . I (37.8) 375 I .9 ( 16.5) 593.6 (2.6) 22676.5

hTotals may difl'er from the sum of other columns betause of rounding. Sorircc,: Calculated by author. based on CDIAC (1993).

lY61 3469.8 (36.4) 4968.4 (52.1) 930.7 (9.8) 164.9 (1.7) 9533.7

Includes emissions from gas flaring as they are released as a product of petroleum extraction.

Ntririrtrl Rewrrces Foriini I995 Voliinie I 9 Nimihrr 3 I87

Conlrolling crnissions qfgrrenl1art.w gclses: F Neio

Table 5 Carbon dioxide emissions from industrial processes for the 30 countries with highest emissions in 1991

Country CO2 emissions C D P Population CDP per capita Emission Emissions per GDP (million tonnes) (billion USS) (millions) (lo00 S) per capita (tonnes per USSIOOOO)

USA Former USSR China Japan Germany India UK Canada Italy France Mexico Poland South Africa Korea, Republic of Australia Korea, D.P.R. of Iran Spain Brazil Saudi Arabia Czech Republic and Slovakia Indonesia Turkey Netherlands Romanin Venezuela Argentina Belgium Thailand Nigeria Total Rest of the world Grand total

493 I .6 358 I .2 2543.4 1091.1 969.6 703.6 577.2 410.6 402.5 374. I 339.9 308.2 278.7 264.6 261.8 243.2 222.4 219.9 215.6 2 14.9 191.4 170.5 142.6 139.0 138.0 121.6 115.8 102.1 100.9 91.9

I9 467.9 3204.9

22 672.8

5610.8 1667.0 369.7 3362.3 1574.3 22 I .9 876.8 510.8

I 150.5 1199.3 282.5 78.0 91.2 283.0 299.8 23.3 97.0 527. I 414.1 108.6 33.2 116.5 95.8 290.7 27.6 53.4

I 14.3 196.9 93.3 34. I

252.5 283.1

1171.0 124.0 79.9 862.7 57.6 27.0 57.7 57.0 83.3 38.3 38.9 43.8 17.3 22.2 60.0 39.0 151.6 15.4 15.7

187.7 57.2 15.0 23.3 19.8 32.7 10.0 55.4 112.1

22.2 19.5 5.9 12.6 0.3 2.2 27. I 8.8 19.7 12.1 0.3 0.8 15.2 10.0 18.9 15.2 19.9 7.0 21.0 6.6 3.4 4.1 2.0 8.0 2.3 7.2 6.5 6.0 17.3 15.1

I .o 11.0 1.6 3.7 13.5 5.6 2.7 1.4 7. I 14.0 2. I 12.2 0.6 0.9 1.7 2.5 IY.4 9.3

I .2 5.9 2.7 6.1 3.5 3.5 19.7 10.2

I .7 I .8 0.3 0.8

8.8 21.5 68.8 3.2 6.2 31.7 6.6 8.0 3.5 3. I 12.0 39.5 30.6 9.4 8.7

104.4 22.9 4.2 5.2 19.8 57.6 14.6 14.9 4.8

50.0 22.8 10.1 5.2 10.8 27.0

Sorrrces: Carbon dioxide emissions calculated from the data set on nationill carbon emissions compiled by the CDIAC (1993). All 19Y I GDP Figures are estimated by UN/DESIPA and World Bank (1993). All 1991 population figures are estimated by UN/DESIPA (1993b). The grand total of carbon dioxide emissions comprises data for 218 countries and territories compiled by the CDIAC (1993).

current global warming patterns are a result of the cumulative amount of greenhouse gases concen- trated in the atmosphere over decades or even centu- ries. It is estimated that the time taken for the natural removal from the atmosphere of any given emission of CO2 varies from 50 to 200 years (IPCC, I99 I). As a consequence, COZ emitted into the atmosphere over a century ago contributes to current patterns of global warming.

This amount of C02 and other greenhouse gases remaining in the atmosphere as a result of a nation’s past emissions is sometimes called a ‘natural debt’. According to Smith (1993, p 3 9 , while a national debt is accumulated by borrowing financial resources from the future, a natural debt ‘is built by borrowing assimilative capacity of the atmosphere from the future, through the release of greenhouse gases faster than they can be naturally removed’. To the extent that there is now fairly accurate data on anthropogenic C02 emissions for most countries dating back to 1950 (see CDIAC, 1993), i t might be useful to introduce a cumulative criterion into initial allocations of permits in a global tradable system.

Conclusion

In theory, the main advantage of a global tradable permit system in the context of the climate change debate is that i t can reduce greenhouse gas emissions by a quantifiable level and at the least economic cost. As argued above, such a system could offer a feasible and cost-effective market-based option for controlling global greenhouse gas emissions, provided that i t is properly targeted at specific gases and sources of emissions. This article has shown that limiting a gIobal permit system to anthropogenic C02 emissions from industrial processes would not only facilitate its implementation and monitoring, but also contribute to substantial reductions of greenhouse gas emissions as a whole.

Nevertheless, global emissions trading should go hand in hand with other policy options, including regulation of certain environmentally unsound activities. In addition, other market-based mechanisms, such as external offsets, can be introduced as a first step towards or complement to global emissions trading. Despite their limitations, offset mechanisms provide a flexible channel both for global emissions

I88 Nnrriral Resorrrces Forirni 1995 Volume 19 Number 3

Table 6 Carbon dioxide emitters from industrial processes in 1991 (ranking according to emissions per unit of CDP)

Country COt emissions GDP Population GDP per capita Emissions per GDP (million tonnes) (billion S) (millions) (lo00 S) (tonnes per USSl0000)

KoreJ, D.P.R. of China Czech Republic and Slovakia Romania Poland lndiii South Africa Nigeria Iran Venezuela Former USSR Saudi Arabia Turkey Indonesia Mexico Thailand Argentina Korea, Rep. of USA Australia Canada UK Germany Brazil Belgium Netherlands Spain Italy Jnpnn France Total Rest of the world Grand total

243.2 2543.4

191.4 138.0 308.2 703.6 278.7 91.9

222.4 121.6

3581.2 2 14.9 142.6 170.5 339.9 100.9 115.8 264.6

493 I .6 261.8 410.6 577.2 969.6 215.6 102.1 139.0 2 19.9 402.5

1091.1 374.1

19 224.6 3448.2

22 672.8

23.3 369.7

33.2 27.6 78.0

22 I .9 91.2 34. f 97.0 53.4

1667.0 108.6 95.8

116.5 282.5

93.3 114.3 283.0

56 10.8 299.8 510.8 876.8

1574.3 414.1 196.9 290.7 527. I

I 150.5 3362.3 I 199.3

22.2 1171.0

15.7 23.3 38.3

862.7 38.9

112.1 60.0 19.8

283. I 15.4 57.2

187.7 83.3 55.4 32.7 43.8

252.5 17.3 27.0 51.6 79.9

151.6 10.0 15.0 39.0 57.7

124.0 57.0

I .o 0.3 2. I I .2 2.0 0.3 2.3 0.3 I .6 2.7 5.9 7. I I .7 0.6 3.4 I .7 3.5 6.5

22.2 17.3 18.9 15.2 19.7 2.7

19.7 19.4 13.5 19.9 27. I 21.0

104.4 68.8 57.6 50.0 39.5 31.7 30.6 27.0 22.9 22.8 21.5 19.8 14.9 14.6 12.0 10.8 10.1 9.4 X.8 8.7 8.0 6.6 6.2 5.2 5.2 4.8 4.2 3.5 3.2 3. I

(mean = 21.2)

Soirrws: Carbon dioxide emissions calculated from the data set on national carbon emissions compiled by the CDIAC (1993). All 1991 GDP ligures are estimated by UN/DESIPA and World Bank (1993). All I991 population figures are estimated by UN/DESIPA (I993b). The grand lotol of carbon dioxide emissions comprises data for 218 countries and territories compiled by the CDIAC (1993).

control and for resource transfer to developing countries with high emissions per unit of output. Simi- larly, even if there are serious obstacles to the introduction of a global carbon tax, in some ways emission taxes would contribute to emissions control more efficaciously than tradable permits. For example, the existence of innumerable small sources of COz, such as motor vehicles and aircraft, suggests that a carbon tax would be more appropriate than emissions trading for controlling individual emissions.

This last example implies that different market- based mechanisms for emissions control should be targeted at different economic actors, that is, individual consumers, farmers, industrial corporations and sovereign states. As recent US experience suggests, emissions trading is best targeted at the level of firms, notably power plants and other heavily polluting industries. At this level, they are not only feasible and manageable but also effective in reducing emissions to a given level, since the targeted industries are responsible for a large amount of emissions. However, i t is also evident that success depends on the satisfactory operation of

a global market for emission permits. Notwith- standing a series of imaginative proposals on how hypothetical markets for emissions trading would or should operate (see, for example, UNCTAD. 1992; OECD. 1992b; Hayes and Smith. 1993), this is an area that requires further research, particularly in view of the problems faced by the market for sulphur dioxide permits in the USA.

Suffice it to say that a discussion of the hypothetical dynamics of such markets lies outside the scope of this paper, of which the ultimate aim was simply to propose baseline criteria for the formulation of a global tradable permit system for COt emissions. In sum, the paper has suggested the following criteria to be considered in the establishment of such a system:

0 placement of focus on anthropogenic C02 emissions as opposed to comprehensive strategies which cannot be properly monitored;

0 promotion ofcleaner fossil fuels, such as natural gas; 0 use of economic or demographic criteria to deter-

mine initial allocation of permits; and 0 consideration of cumulative emissions as a

measure of natural debt.

Ntrttrruf RLwmce.s Forum 199.5 Vt,/innc) 19 Nitmher 3 I89

Cort t rolliiig ivi I issior i s if.qrcwilto I ~ s c ~ grrsc~s: F ,Vcq o

Table 7

Country COz emissions GDP Population GDP per capita Emissions per capita

Carbon dioxide emitters from industrial processes in 1991 (ranking according to emissions per capita)

(million tonnes) (billion $) (millions) (1m S)

USA C,l nndil Australin Suudi Arabia Former USSR Czech Republic and S1ov;ikin Germany Korea. D.P.R. of Belgi um United Kingdom Netherlands Japan Poland South Africa Italy France Venezuela Korea. Rep. of Romuni:i Spain Mexico Iran Argentins Turkey China Thailiind Brazil Indonesia Nigcrin India Totill Rest ol' the world Grnnd total

493 I .6 4 I0.h 26 I .8 2 14.9 358 I .2 191.4 969.6 243.2 102.1 577.2 139.0 1091.1 308.2 278.7 402.5 374. I 121.6 264.6 138.0 219.9 339.9 222.4 115.8 142.6 2543.4 100.9 2 15.6 170.5 91.9 703.6

14 536.2 8136.6

22 672.8

56 10.8

299.8 108.6 1667.0 33.2

1574.3 23.3 196.9 876.8 290.7 3362.3 78.0 91.2

I 150.5 1199.3 53.4 283.0 27.6 527. I 282.5 97.0 114.3 95.8 369.7 93.3 414.1 I 16.5 34. I 22 I .Y

sio.8 252.5 27.0 17.3 15.4 283. I 15.7 79.9 22.2 10.0 57.6 15.0 124.0 38.3 38.9 57.7 57.0 19.8 43.8 23.3 39.0 83.3 60.0 32.7 57.2

1171.0 55.4 151.6 187.7 112.1 862.7

22.2 18.9 17.3 7. I 5.9 2. I 19.7

I .o 19.7 15.2 19.4 27. I 2.0 2.3 19.9 21.0 2.7 6.5 I .2 13.5 3.4 I .6 3.5 I .7 0.3 I .7 2.7 0.6 0.3 0.3

19.5 I 5.2 15.1 14.0 12.6 12.2 12.1 11.0 10.2 10.0 9.3 8.8 8.0 7.2 7.0 6.6 6. I 6.0 5.9 5.6 4. I 3.7 3.5 2.5 2.2 I .8 I .4 0.0 0.8 0.8

(mean = 7.5)

~~ ~~~~~ ~ ~ ~~~~

Sorircc~.v: Carbon dioxide emissions calculated from the diitu set on n;ition;ll carbon cmissions compiled by the CDIAC (1993). All 1901 GDP ligurcs iirc cstirniitcd by UN/DESIPA and World Blink (1993). All I09 I population figures are estimated by UN/DESIPA (IYY3b). The grand tokil ol'cnrbon dioxidu missions comprises diitn for 118 countrics nnd territories compiled by the CDIAC ( 1993).

Acknowledgements

The author wishes to thank David Gold, Hiroshi Kawamura. Peter Koudal and Larry Willmore for their comments on a n earlier draft of this article. Thanks are also due to Gregg Marland of the Carbon Dioxidc Information Analysis Center (CDIAC) for answering a number of queries about the data set on world CO? emissions. This article reflects the views of the author and not necessarily those of the United Nations.

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Documents

Market-based mechanisms for controlling global emissions of greenhouse gases : Possible reference bases for international agreements