Program on Information and Resources Columbia University 1 Economic Returns from the Biosphere Pegram Lectures Brookhaven National Laboratories Graciela.

Program on Information and Resources Columbia University 1 Economic Returns from the Biosphere Pegram Lectures Brookhaven National Laboratories Graciela Chichilnisky UNESCO Chair in Mathematics and Economics Columbia University

Program on Information and Resources Columbia University 2

3 Human beings, or their close genetic relatives, have lived on Earth for several million years Yet only recently has human activity reached levels at which it can affect fundamental natural processes the concentration of gases in the atmosphere (CO2, Ozone) the concentration of gases in the atmosphere (CO2, Ozone) the planet’s water mass the planet’s water mass The complex web of species which constitute life on earth The complex web of species which constitute life on earth

Program on Information and Resources Columbia University 4 Changes in global atmospheric composition Fossil Fuel Consumption Forest Burning Refrigerants Foam Blowing Solvents Rice Paddies Marshlands Cattle Sources: The Facts - Trace Gas Concentrations are increasing Source: World Resources Institute, 2002

6 Source: National Oceanic and Atmospheric Administration (NOAA). US Department of Commerce. http://www.noaa.gov/

Program on Information and Resources Columbia University 7 Policy responses 1992 Rio targets: roll back industrial countries emission to 1990 levels by 2000 1992 Rio targets: roll back industrial countries emission to 1990 levels by 2000 Since then emissions have increased Since then emissions have increased Little progress has been achieved Little progress has been achieved

Program on Information and Resources Columbia University 8 Source: National Oceanic and Atmospheric Administration (NOAA). US Department of Commerce. http://www.noaa.gov/

Program on Information and Resources Columbia University 9 Sources: “A timeline of climate change” Matthew Knight, CNN science, 14, May 2008. http://www.cnn.com/2008/TECH/science/03/31/Intro.timeline/index.html (the rest came from G. Chichilnisky directly). http://www.cnn.com/2008/TECH/science/03/31/Intro.timeline/index.html

Program on Information and Resources Columbia University 10 How to achieve the Rio targets? Proposals: Global carbon taxes (OECD Study, 1993 – 4 Global carbon taxes (OECD Study, 1993 – 4 Global markets for carbon emission permits (Chichilnisky, 1993: proposal to OECD, to UN Framework Convention on Climate Change, Chair R. Estrada-Oyuela, and to World Bank 1995 Global markets for carbon emission permits (Chichilnisky, 1993: proposal to OECD, to UN Framework Convention on Climate Change, Chair R. Estrada-Oyuela, and to World Bank 1995

Program on Information and Resources Columbia University 11 1995 Berlin Mandate Negotiate Protocol to quantify limitations by industrial countries, e.g. in 2000, 2010, 2020 Negotiate Protocol to quantify limitations by industrial countries, e.g. in 2000, 2010, 2020 Joint implementations pilot Joint implementations pilot Prelude to emissions trading Prelude to emissions trading

Program on Information and Resources Columbia University 12 Geneva: June 1996 U.S. Tim Wirth proposes global emission markets U.S. Tim Wirth proposes global emission markets

Program on Information and Resources Columbia University 13 ● In 1996, the IPCC reported that human induced emissions of carbon have a discernible effect on climate ● Scientific uncertainty persists ● But the risk of climate change is real and potentially catastrophic

Program on Information and Resources Columbia University 14 Kyoto: 1997 166 nations accepted our emissions market proposal to UNFCCC 166 nations accepted our emissions market proposal to UNFCCC The Kyoto Protocol

Program on Information and Resources Columbia University 15 Kyoto set 5% emission reductions for Annex 1 countries by 2008- 2012 and created three facilitating mechanisms to achieve this

Program on Information and Resources Columbia University 16 The Kyoto Protocol sets caps on CO 2 emissions, and allows industrial nations to trade the rights to emit

Program on Information and Resources Columbia University 17 Facilitating mechanisms for Annex 1 countries: Joint implementation (article 6) Joint implementation (article 6) Emission trading (article 17) Emission trading (article 17) See also art 3.10 and 3.11 See also art 3.10 and 3.11

Program on Information and Resources Columbia University 18 Only one mechanism involves both industrial and developing countries: CLEAN DEVELOPMENT MECHANISM (ARTICLE 12)

Program on Information and Resources Columbia University 19 1993 BUENOS AIRES COP4 Set 2 year deadline for completing the KYOTO AGENDA

Program on Information and Resources Columbia University 20 The Kyoto Protocol sets caps on CO 2 emissions, and allows industrial nations to trade the rights to emit

Program on Information and Resources Columbia University 21 TODAY The profits obtained are the same for a Ford factory that produces cars in China using dirty technology or clean technology The profits obtained are the same for a Ford factory that produces cars in China using dirty technology or clean technology

Program on Information and Resources Columbia University 22 BALI - COP 13: The Bali Roadmap COPENHAGEN COP15 Reducing the U.S. – China impasse A NEW COLD WAR?

Program on Information and Resources Columbia University 23 Three outstanding issues for implementation of the Kyoto Protocol: Opposition from the private sector Opposition from the private sector Developing countries do not participate in emissions limits Developing countries do not participate in emissions limits U.S.-China impasse: A new Cold War? U.S.-China impasse: A new Cold War?

Program on Information and Resources Columbia University 24 Both issues arise from fears that emissions limits will interfere with economic growth and the rise in standards of living

Program on Information and Resources Columbia University 25 How to cut the link between emissions and economic growth? Only new clean technologies can achieve this

Program on Information and Resources Columbia University 26 New technology requires appropriate economic conditions to be implemented. Resource prices are key

Program on Information and Resources Columbia University 27 Prices have an impact A much-quoted statistic on this subject is that the amount of energy used in producing $1000-worth of constant-dollar GNP in the USA fell by 38.9% from 1973 to 1983. A much-quoted statistic on this subject is that the amount of energy used in producing $1000-worth of constant-dollar GNP in the USA fell by 38.9% from 1973 to 1983. This was a result of switching to more energy-efficient technologies, and mostly of demand patterns changing away from energy intensive products and services. Most of this striking drop in energy use occurred in the period 1979-1983.

Program on Information and Resources Columbia University 28 New Technologies (fuel cells, solar) seem uncompetitive because of excessively low resource prices In real terms, oil prices are the lowest ever today

Program on Information and Resources Columbia University 29 Through clean technologies, developing countries can “leapfrog”, without repeating the resource-intensive growth that characterizes industrial countries

Program on Information and Resources Columbia University 30 Technology transfers and emissions trading Today there is no incentive for a USA corporation to set plants in developing countries using modern, clean technology

Program on Information and Resources Columbia University 31 EMISSIONS MARKETS Change all this They reward the transfers of clean technology How?

Program on Information and Resources Columbia University 32 If Ford is allocated permits for clean car technology corresponding to the emissions saved, it can cash these permits in the emissions market

Program on Information and Resources Columbia University 33 Markets for Emission Permits Annex 1 Countries are given allocations of property rights on emissions summing up to a 5% reduction, and they can trade these freely among themselves

Program on Information and Resources Columbia University 34 EXAMPLES The trading of SO 2 in the Chicago Board of Trade since 1993, following the Clean Air Act The trading of SO 2 in the Chicago Board of Trade since 1993, following the Clean Air Act Proposed Water Markets in California Proposed Water Markets in California

Program on Information and Resources Columbia University 35 Biodiversity and Markets for emissions permits Deforestation is the source of approximately 20% of global greenhouse gas emissions. Science has shown that forests act as “sinks” retaining large amounts of carbon and absorbing large quantities of carbon dioxide Deforestation is the source of approximately 20% of global greenhouse gas emissions. Science has shown that forests act as “sinks” retaining large amounts of carbon and absorbing large quantities of carbon dioxide

Program on Information and Resources Columbia University 36 Biodiversity and Markets for emissions permits The Bolivian government has added 2.1 million acres of tropical forest land to the Noel Kempff Mercado National Park, essentially doubling its size. By investing in the protection of this area, three U.S. corporations, American Electric Power, BP America and Pacific Corp., and the Bolivian government will receive carbon offset credits. These credits could have significant market value, should a trading system develop as a result of international negotiations stemming from the December 1997 Kyoto conference on climate change The Bolivian government has added 2.1 million acres of tropical forest land to the Noel Kempff Mercado National Park, essentially doubling its size. By investing in the protection of this area, three U.S. corporations, American Electric Power, BP America and Pacific Corp., and the Bolivian government will receive carbon offset credits. These credits could have significant market value, should a trading system develop as a result of international negotiations stemming from the December 1997 Kyoto conference on climate change

Program on Information and Resources Columbia University 37 Market Innovation New Markets are created, which trade property rights on the use of the Global Commons New Markets are created, which trade property rights on the use of the Global Commons

Program on Information and Resources Columbia University 38 The Emergence of Global Environmental Markets The Kyoto Protocol

Program on Information and Resources Columbia University 39 Financial Innovation Offers A Solution New York purchased conservation land in the Catskills New York purchased conservation land in the Catskills The $660 million purchase was paid by selling an environmental bond The $660 million purchase was paid by selling an environmental bond New York saved $3.34 billion by conserving the watershed New York saved $3.34 billion by conserving the watershed

Program on Information and Resources Columbia University 40 Financial instruments to preserve and realize the value of watersheds For decades the water of New York is purified by micro-organisms in the Catskill soil For decades the water of New York is purified by micro-organisms in the Catskill soil Their survival is threatened today by pesticides and fertilizers Their survival is threatened today by pesticides and fertilizers A $6 billion purification plant would be needed if they disappeared A $6 billion purification plant would be needed if they disappeared Trading an innovative environmental bond, New York purchased conservation land for $680 million in the Catskills, thus avoiding the cost of the plant Trading an innovative environmental bond, New York purchased conservation land for $680 million in the Catskills, thus avoiding the cost of the plant

Program on Information and Resources Columbia University 41 The watershed problem is global The value of watershed services to major cities across the world is estimated at $900 billion The value of watershed services to major cities across the world is estimated at $900 billion One can securitize watershed services through innovative financial instruments One can securitize watershed services through innovative financial instruments

Program on Information and Resources Columbia University 42 SECURITIZATION Form corporation to manage conservation Form corporation to manage conservation Corporation owns the cost savings from conserving watershed Corporation owns the cost savings from conserving watershed Finance conservation by selling shares Finance conservation by selling shares Local community and state should own shares Local community and state should own shares

Program on Information and Resources Columbia University 43 Increased knowledge can help How? It can lead to: Better understanding of natural risks and how to manage them (El Nino and catastrophic bundles) Better understanding of natural risks and how to manage them (El Nino and catastrophic bundles) Better understanding of human impacts on nature and of new courses of action (watersheds and environmental bonds Better understanding of human impacts on nature and of new courses of action (watersheds and environmental bonds

Program on Information and Resources Columbia University 44 Markets are widely used institutions They are decentralized, and can be efficient. But global environmental markets trade unusual goods: privately produced public goods ● Biodiversity is one ● The planet’s atmosphere is another

Program on Information and Resources Columbia University 45 Environmental assets are often public goods CO 2 concentration in the atmosphere is a quintessential public good because it mixes very thoroughly throughout the planet and is very stable (remains about 100 years) CO 2 concentration in the atmosphere is a quintessential public good because it mixes very thoroughly throughout the planet and is very stable (remains about 100 years) It is not a typical public good because it is not produced by the government such as defense It is not a typical public good because it is not produced by the government such as defense CO 2 is privately produced CO 2 is privately produced

Program on Information and Resources Columbia University 46 Public goods change matters New Economic Findings Only certain allocations of property rights on the atmosphere between countries will yield efficient market solutions Only certain allocations of property rights on the atmosphere between countries will yield efficient market solutions This ties together the goals of efficiency and fairness: This ties together the goals of efficiency and fairness: The aspirations of North and South The aspirations of North and South

Program on Information and Resources Columbia University 47 Privately produced public goods are goods which are not “rival” in consumption, but are privately produced are goods which are not “rival” in consumption, but are privately produced we all produce emissions but the atmosphere is the same for us all we all produce emissions but the atmosphere is the same for us all

Program on Information and Resources Columbia University 48 First Theorem of Welfare Economics The allocation resulting from a competitive market equilibrium with private goods is Pareto efficient (Arrow, 1950) This theorem is independent of the distribution of property rights. For example: all but two traders may have zero endowments of property rights and the resulting equilibrium is still Pareto efficient. This theorem is independent of the distribution of property rights. For example: all but two traders may have zero endowments of property rights and the resulting equilibrium is still Pareto efficient.

Program on Information and Resources Columbia University 49 But it requires all traded goods to be private goods, with rival consumption, and privately owned. But it requires all traded goods to be private goods, with rival consumption, and privately owned.

Program on Information and Resources Columbia University 50 Markets with PPP goods are different from standard markets In private goods markets, efficiency and fairness are separate concepts In markets with privately produced public (PPP) goods these two concepts are linked

Program on Information and Resources Columbia University 51 With private goods efficiency requires that MRS=MRT, but with public goods the formula changes: Linden-Bowen and Samuelson proved that: Sum of MRS across people = MRT

Program on Information and Resources Columbia University 52 ● For efficient markets, traders should choose freely between private goods and environmental quality ● However the atmosphere concentration of CO 2 is one and the same for all. This is an unavoidable physical fact

Program on Information and Resources Columbia University 53 ● Therefore free choice must lead every trader to select the same overall trade-off between private goods and atmospheric quality ● For this to happen, trader’s wealth should not be too far apart

Program on Information and Resources Columbia University 54 ● Efficiency and distribution are connected in markets with PPP goods ● A measure of equity is necessary for efficiency ● Markets with knowledge and environmental assets require equity for efficiency

Program on Information and Resources Columbia University 55 First Welfare Theorem in Markets with Privately Produced Public Goods Only a finite number of ways of distributing property rights on a given total of emissions rights between the traders gives rise to efficient market allocations Only a finite number of ways of distributing property rights on a given total of emissions rights between the traders gives rise to efficient market allocations

Program on Information and Resources Columbia University 56 ● Efficiency and distribution are closely connected in economies with environmental assets ● A measure of equity is necessary for efficiency

Program on Information and Resources Columbia University 58 POLICY Those who have fewer endowments of private goods must be endowed with more property rights on the use of the PPP good. Otherwise the market does not operate efficiently Those who have fewer endowments of private goods must be endowed with more property rights on the use of the PPP good. Otherwise the market does not operate efficiently

Program on Information and Resources Columbia University 59 ● One way to ensure this is to follow a simple rule: the countries that emit less receive somewhat more permits: ● A “reverse grand-fathering” allocation ● Repeated across time, such a policy would compensate those who use the atmosphere judiciously and provide incentives to abate

Program on Information and Resources Columbia University 60 This scheme: Rewards the transfers of clean technology to developing countries Rewards the transfers of clean technology to developing countries Multiplies the returns on R&D in the private sector Multiplies the returns on R&D in the private sector Securitizing these returns attracts global capital from private sources for clean technology transfers Securitizing these returns attracts global capital from private sources for clean technology transfers

Program on Information and Resources Columbia University 61 A market has N traded goods and H traders Each trader has a preference u h : R N R and and allocation of property rights Ω h Є R N. Ω h Є R N. NEW MARKETS

Program on Information and Resources Columbia University 62 What is economic efficiency: A feasible allocation is Pareto efficient if there is no other feasible allocation which makes everybody as well off, and some strictly better off A feasible allocation is Pareto efficient if there is no other feasible allocation which makes everybody as well off, and some strictly better off

Program on Information and Resources Columbia University 63 A competitive equilibrium is a price p*  R N and an allocation x 1,…,x H  R N x H such that each trader maximizes utility subject to a budget constraint: Max (u h (y)) for y  {z Є R N : = } And markets clear: Σ x h = Σ Ω h. HH h=1

Program on Information and Resources Columbia University 64 A competitive market equilibrium Is a set of prices p* and an allocation of goods x 1,…, x H  R N x H at which each trader maximizes utility subject to a budget constraint, and all markets clear.

Program on Information and Resources Columbia University 65 A General Model Consider a world economy with I countries, I ≥ 2, indexed by i = 1,…,I. Each has a utility function u i, arguments a vector of private goods c i = (c i,1,c i,2,…,c i,m ) where m is the number of private goods, and also the quality of the world’s atmosphere, a, which is a public good. The quality of the atmosphere, a, is measured by the reciprocal or the negative of CO 2 concentration. The concentration of CO 2 is “produced” by emissions of carbon, which are positively associated with the production of private goods.

Program on Information and Resources Columbia University 66 Let y be a vector giving the production levels of the m private goods in the country i. a = Σ a i, a i = Φ (y i ) and < 0  i. a is a measure of atmospheric quality overall, and a i is an index of the abatement carried out by country i. Feasibility is defined by the above and by the condition that the total consumption of each private good worldwide equal total production,  c i =  y i This allows unrestricted lump sum redistributions. I i=1    y i,l i=1,…,I

Program on Information and Resources Columbia University 67 A Pareto efficient allocation is the solution to the problem of maximizing the utility of a designed country, subject to the other countries all reaching prescribed utility levels. This gives the following conditions: A Pareto efficient allocation is the solution to the problem of maximizing the utility of a designed country, subject to the other countries all reaching prescribed utility levels. This gives the following conditions: = λ k  l = 1,…,m and  k  i. = λ k  l = 1,…,m and  k  i. This implies common MRS for all countries. Country i is the country whose utility is being maximized, and λ k is a Lagrange multiplier associated with the constraint that country k reach a specified welfare level, and This implies common MRS for all countries. Country i is the country whose utility is being maximized, and λ k is a Lagrange multiplier associated with the constraint that country k reach a specified welfare level, and =  l,  u i  c i,l  u k  c i,l  i  y i,l  u k  c i,l  k k  u k  a

Program on Information and Resources Columbia University 68 First Welfare Theorem for Markets with Privately Produced Public Goods Theorem In an economy with k 2 traders, j 1private goods and a public good, there exists at most a one-dimensional manifold o property rights allocations on the use of the public good (allocation of “permits”) from which the competitive equilibrium is Pareto efficient. This is the Manifold of Efficient Allocations of Property Rights

Program on Information and Resources Columbia University 69 First Welfare Theorem In Markets with Privately Produced Public Goods There is only a finite number of ways of distributing property rights on a given total environmental use between the traders so that the market equilibrium is Pareto efficient There is only a finite number of ways of distributing property rights on a given total environmental use between the traders so that the market equilibrium is Pareto efficient Typically efficiency requires that those with fewer endowments of private goods should have a higher allocation of property rights on the public goods Typically efficiency requires that those with fewer endowments of private goods should have a higher allocation of property rights on the public goods Chichilnisky, 1992-3 Chichilnisky and Heal, 1993 Chichilnisky, Heal and Starrett, 1993-4

Program on Information and Resources Columbia University 70 Simple Example of a Market with Privately Produced Public Goods Two Countries, i=1,2 Two Goods: one private: x one private: x and one public: a = abatement = -emissions and one public: a = abatement = -emissions Initial data: (1) the technology  a  x, And (2) the property rights on the use of the public good, a i,    a 1 = a a i,    a 1 = a

Program on Information and Resources Columbia University 71 Each Country solves the following problem: ( * ) Max u i (x i,a), ( * ) Max u i (x i,a), Such that x i =  a i  ( a i – a i ),  ’  where is the market price of x relative to a. At World Market Equilibrium each country maximizes utility (*), and markets clear  a i =  a i = a ii

Program on Information and Resources Columbia University 73 New Economic Findings Efficiency in trading permits requires more emission rights to developing countries Efficiency in trading permits requires more emission rights to developing countries Why? Why?

Program on Information and Resources Columbia University 74 Experiments with GREEN MODEL Show that the world cost of abatement is lower when the South is given proportionately more permits Show that the world cost of abatement is lower when the South is given proportionately more permits

Program on Information and Resources Columbia University 75 Experiments with Columbia-Green model: General equilibrium model with permit markets General equilibrium model with permit markets 12 regions 12 regions 12 by 12 international trade matrix 12 by 12 international trade matrix 8 sectors 8 sectors Experiments lead to similar finding, i.e. equity and efficiency are connected Experiments lead to similar finding, i.e. equity and efficiency are connected

Program on Information and Resources Columbia University 76 Sensitivity analysis of the OECD- PIR global model shows that it is more efficient to allocate somewhat more permits to developing countries Currently the N-S per capita difference in emissions is 6:1 Currently the N-S per capita difference in emissions is 6:1 IN the case of U.S. the difference is 10:1 IN the case of U.S. the difference is 10:1 Developing countries with more than 86% of the world population emit less than 70% of the total carbon emissions Developing countries with more than 86% of the world population emit less than 70% of the total carbon emissions

Program on Information and Resources Columbia University 83 Present Value of Real Income Loss over 2000-2050 (in percentage deviation relative to BaU) INDIVIDUALSTABLILITYUNIFORMTAXGRANDFATHERINGPOPULATIONBASEDMIXED USAJPN-O.79-2.41-0.90-1.24-0.76-1.83-2.94-2.84-1.84-2.34 EECOOE-1.23-0.58-1.16-0.55-1.22-0.54-3.13-1.53-2.19-1.04 EEXCHN-3.39-3.88-0.83-3.47-0.78-4.14 0.09 0.09 6.02 6.02-0.39 1.04 1.04 FSUIND-1.42-2.61-2.66-2.00 1.08 1.08-2.94-7.13 14.62 14.62-2.92 7.00 7.00 EETDAE-0.33-0.29-1.09 0.16 0.16 0.81 0.81 0.20 0.20-5.94 0.19 0.19-2.51-0.05 BRAROW-1.60-0.40-1.78-0.01-4.40 0.05 0.05-0.55 0.21 0.21-2.45 0.12 0.12 WORLD-1.65-1.16-1.17-1.06-1.07

Program on Information and Resources Columbia University 84 This is because each dollar of investment yields more output in the South

Program on Information and Resources Columbia University 88 TODAY There is a general agreement that making accessible more development funding for poor countries in a controlled and incremental fashion could benefit the world economy as a whole There is a general agreement that making accessible more development funding for poor countries in a controlled and incremental fashion could benefit the world economy as a whole

Program on Information and Resources Columbia University 89 TODAY There is a general agreement that something must be done at the international level There is a general agreement that something must be done at the international level Kyoto, December 1997 could be a turning point Kyoto, December 1997 could be a turning point

Program on Information and Resources Columbia University 90 ● Yet in the global negotiations, the division between industrial and developing nations is as deep as ever ● There is a general agreement that without bridging North-South gap there will be no real progress How to move ahead?

Program on Information and Resources Columbia University 91 One way to ensure this is to follow a simple rule: the countries that emit less receive somewhat more permits: One way to ensure this is to follow a simple rule: the countries that emit less receive somewhat more permits: A “reverse grand-fathering”allocation A “reverse grand-fathering”allocation Repeated across time, such a policy would compensate those who use the atmosphere judiciously and provide incentives to abate Repeated across time, such a policy would compensate those who use the atmosphere judiciously and provide incentives to abate

Program on Information and Resources Columbia University 92 The Key Issues Allocation of rights on the use of the atmosphere This is a question of efficiency as well as equity More on this in the lecture

Program on Information and Resources Columbia University 93 How to resolve the China-US Impasse New Financial mechanism New Technologies

Program on Information and Resources Columbia University 94 Technology Transfer Negative Carbon Market To increase clean energy Reduce carbon in the atmosphere

Program on Information and Resources Columbia University 95 New Financial Mechanisms Based on Carbon Market Replicating Article UNFCCC Giving North and South what they want

Program on Information and Resources Columbia University 1 Economic Returns from the Biosphere Pegram Lectures Brookhaven National Laboratories Graciela.

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Program on Information and Resources Columbia University 1 Economic Returns from the Biosphere Pegram Lectures Brookhaven National Laboratories Graciela.

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