The Economics of Climate Change: An Economic Critique of Kyoto, and an Alternative Proposal Dr. Arne Kildegaard University of Minnesota, Morris

Directions to Morris…

Greenhouse Gases (GHGs) and the atmosphere

CO2 Emissions and Concentrations

CO2 Emissions

CO2 Concentrations and Temperature

Temperature Change

The Industrial Revolution: A Revolution in Energy Usage BeforeAfter

Revolution in Energy Use (cont’d.) Exploitation of carbon-based fossil fuels Exploitation of carbon-based fossil fuels Consequent CO2 emissions Consequent CO2 emissions Deforestation (elimination of carbon sinks) Deforestation (elimination of carbon sinks) Consequent elimination of carbon sinks Consequent elimination of carbon sinks  Inevitably, higher atmospheric concentrations

Other GHGs Methane Methane Nitrous Oxide Nitrous Oxide Hydroflourocarbons (HFCs) Hydroflourocarbons (HFCs) Perflourocarbons (PFCs) Perflourocarbons (PFCs) Sulphur hexaflouride Sulphur hexaflouride

Consequences: a non-exhaustive list (from the UNIPCC) Rising sea levels Rising sea levels Island nations and coastal cities Island nations and coastal cities Freshwater resources (desertification) Freshwater resources (desertification) Human health Human health Vector-borne diseases (e.g. malaria) Vector-borne diseases (e.g. malaria) Agriculture Agriculture Cereal production to fall 20% by some GE analyses Cereal production to fall 20% by some GE analyses Redistribution from tropics to temperate zones Redistribution from tropics to temperate zones Species and habitat Species and habitat

Can’t we all just get along…?

UN Framework Convention on Climate Control (UNCCC) Rio Conference Rio Conference COPs (Council of Parties) Rounds COPs (Council of Parties) Rounds “Targets and Timetables” (COP1) “Targets and Timetables” (COP1) Kyoto Protocol (COP3, December, 1997) Kyoto Protocol (COP3, December, 1997) Subsequent modifications (COP4-10) Subsequent modifications (COP4-10) U.S. Repudiation (March, 2001) U.S. Repudiation (March, 2001)

Key Features of Kyoto, as Amended Targets and Timetables Targets and Timetables  93% of 1990 emissions by  93% of 1990 emissions by Binding restrictions on “Annex” B countries only Binding restrictions on “Annex” B countries only 38 countries + EU 38 countries + EU Tradeable Discharge Permits (TDP) Scheme Tradeable Discharge Permits (TDP) Scheme To minimize total cost of compliance To minimize total cost of compliance Treaty Enters into force when countries comprising 55% of Annex B emissions ratify Treaty Enters into force when countries comprising 55% of Annex B emissions ratify

Problems with Kyoto Economic rationality? Economic rationality? Initial Emissions $ Abatement Marginal Damage Cost Marginal Abatement Cost E* Emissions

Problems with Kyoto, cont’d. Financial Transfers and political sustainability Financial Transfers and political sustainability Wilcoxen & McKibben estimate U.S. permit $27-$54 billion Wilcoxen & McKibben estimate U.S. permit $27-$54 billion Financial Tranfers and economic instability Financial Tranfers and economic instability Dutch Disease Dutch Disease

Problems with Kyoto, cont’d. Who will monitor compliance? Who will monitor compliance? Governments must bear the domestic economic and political costs of monitoring, while whatever benefit is shared internationally. Governments must bear the domestic economic and political costs of monitoring, while whatever benefit is shared internationally.

Problems with Kyoto, cont’d. Which regulatory instrument? It matters… TDPs vs. “Green Taxes” Initial Emissions $ Abatement Marginal Abatement Cost # Permits Emissions

Problems with Kyoto, cont’d. Which regulatory instrument? It matters… TDPs vs. “Green Taxes” Initial Emissions $ Abatement Marginal Abatement Cost Unit emisions tax rate Emissions

TDPs under uncertainty regarding abatement costs (MAC steeper than MDC) MAC (perceived) MAC (actual) Deadweight Loss Emissions Permits

Green taxes under uncertainty regarding abatement costs (MAC steeper than MDC) MAC (perceived) MAC (actual) Deadweight Loss Emissions Permits MDC Tax rate

Choice of Instruments Under Uncertainty When MDC “steeper” than MAC When MDC “steeper” than MAC  TDPs dominate tax schemes When MAC “steeper” than MDC When MAC “steeper” than MDC  Taxes dominate TDP schemes But: “free permits” are politically much more attractive than taxed emissions

Choice of Instrument: A Hybrid Approach At the margin, a tax is better At the margin, a tax is better Why not grant permits for the first n units of emissions, and sell permits at a fixed price thereafter? Why not grant permits for the first n units of emissions, and sell permits at a fixed price thereafter?

Choice of Instruments: A Hybrid Approach MAC (perceived) MAC (actual) Emissions MDC Tax rate Cost of Compliance

Choice of Instruments: A Hybrid Approach MAC (perceived) MAC (actual) MDC Tax rate Permits granted Cost of compliance

Hybrid Approach: Advantages Appropriate instrument, given uncertainties of cost and relative slopes Appropriate instrument, given uncertainties of cost and relative slopes Avoids financial transfers between countries Avoids financial transfers between countries Appropriate incentives to monitor Appropriate incentives to monitor Tax revenues for government Tax revenues for government Firms police each other Firms police each other Flexible Flexible As more scientific information becomes available, countries can change tax level appropriately As more scientific information becomes available, countries can change tax level appropriately

References McKibben and Wilcoxen (2002): “The Role of Economics in Climate Change,” Journal of Economic Perspectives, V.16, No.2, Spring. McKibben and Wilcoxen (2002): “The Role of Economics in Climate Change,” Journal of Economic Perspectives, V.16, No.2, Spring. United Nations Framework Convention on Climate Change Secretariat (2003): “Caring for Climate: A Guide to the Climate Change Convention and the Kyoto Protocol.” United Nations Framework Convention on Climate Change Secretariat (2003): “Caring for Climate: A Guide to the Climate Change Convention and the Kyoto Protocol.”

Discussion…?