Designing International Environmental Agreements Charles D. Kolstad 3M Visiting Professor of Environmental Economics, MIT and Donald Bren Professor of Environmental Economics & Policy, University of California, Santa Barbara

Some Prominent Environmental Treaties CITES—Convention on International Trade in Endangered Species (1973) ICRW—International Convention for the Regulation of Whaling (1946) Montreal Protocol on Substances that Deplete the Ozone Layer (1987)—a protocol of the Vienna Convention (1985) Kyoto Protocol (1997) – a protocol of the UN Framework Convention on Climate Change (1992)

A Century of Environmental Treaties Number by decade of initiation

What’s the Issue? Not a few but MANY environmental treaties Some succeed; some do not What makes a treaty work?

The Card Game Analogy Each player is given two cards: one red and one black Each player will anonymously hand in one card to Center (i.e., to Prof. Kolstad) Payoff to each student after play of game: –5 MIT Bucks for a red card in your hand –1 MIT Buck for each red card Center holds –Maximum payoff: (N-1)+5 [where N = # students] Trade in your MIT Bucks for Wonderful MIT Memorabilia: –Nice MIT Pen – 5 MIT Bucks –Nicer MIT Pen – 8 MIT Bucks –Really nice MIT Pen – 15 MIT Bucks Your task: figure out what to hand in to the Center

Your strategy Hand in your red card –It yields less to you than if you kept it –It yields far more to the group than if you kept it. –Society wants you to hand in your red card Keep your red card –It is worth far more to you in your hand –Your payoff will be higher; society’s lower

Results This experiment has been run many times –typically ⅓ -- ⅔ of people hand in their red card When repeated with the same group, cooperation (handing in the red card) tends to decline Analogous to transboundary environmental problems –Fundamental conflct between individual and group interests –Self-interest diverges from group interest –Powerful incentives to shirk your responsibility Understanding how to solve card problem gives insight into solving transboundary environmental problems

Can an Agreement Solve Problem? What would the agreement involve? –Agree to hand in red card –Needs to involve everyone? Or is subset ok? What should be in the agreement? –Penalties for cheating (ie, not handing in red card) –Penalties for free-riding (ie, not joining but benefiting from agreement) Any other characteristics of agreement? –Should be self-enforcing (ie, no appeal to higher authority) –Must create an aggregate gain to participants –Goes into effect when x% of people agree Agreement must distribute aggregate gain –If people are different, must have side payments –Must be in the self interest of individuals to join

Back to the Real World Card game has lessons for the real world Goal: identify desirable characteristics of international environmental agreements

National vs. International Fundamental Differences in Environmental Regulation NationalInternational Do all participants need to gain? NOYES Needs to be self- enforcing? NOYES Are effective penalties easy? YESNO Will all players participate? YESNO

Desirable Attributes of a Successful Multilateral Environmental Agreement Create an aggregate net benefit to participants –overall gross benefits > overall gross costs Distribute the aggregate gain among participants –For each participant, benefits > costs (individual rationality) –Self-interest important in convincing country to agree Deter non-participation –Must make it undesirable to remain outside agreement –Trade sanctions most frequently used –Design net benefits in > net benefits out (participation constraint) Deter non-compliance among participants –Penalties must be credible –Trade sanctions are easiest to use Deter entry of new non-participants (avoid “leakage”) –Particularly appropriate for common property problems –Saving a fishery increases rents and may induce non-fishing countries to enter

Closer Look at Two Major Treaties Ozone protection in stratosphere – Montreal Protocol Climate change and greenhouse gas emissions – Kyoto Protocol

Montreal Protocol Designed for CFC’s leading to Ozone Depletion Quantitative emission limits for industrial, transition and developing countries Industrial countries pay for added costs to developing countries Trade sanctions for non- participants and violators Initial protocol modest; gradually tightened over 10-year period Ozone Levels Projected Source: World Met Org

UN Framework Convention on Climate Change – Kyoto Protocol Emerged from Rio Conference in 1992 US signed and ratified UNFCCC Modeled after Montreal Protocol Kyoto Protocol (1997) defines emission reductions for Annex I (developed) countries Developing countries largely exempt Penalities for noncompliance missing

Compare Montreal and Kyoto MontrealKyoto Developing Country Reductions? YESNO Permanent?YESNO Emission TradingNOYES Side payments?YESNO Participation incentivesYESNO Leakage prevention?YESNO Adapted from Barrett (2003)

Payoffs to US with and without Montreal Billions of 1985 US$ Montreal Protocol Unilateral Action without Montreal Protocol Benefits3,5751,373 Costs21 Net Benefits 3,5541,352 Source: USEPA (1988), reproduced in Barrett (1999)

Emissions and Costs from Kyoto (Estimate – some controversy here) Base 2015 Emissions 2015 Kyoto Emissions Costs US EU Russia & EE Rest of World WORLD Units: For emissions, billions of tons of carbon; for costs, billions of 1990 US$, NPV Source: Nordhaus and Boyer (2000). Assumes full trading of emission obligations; anthropogenic emissions only.

Lessons Montreal has lessons for Climate Kyoto has ignored most of the important characteristics needed in international environmental agreement Small net benefits for climate has implications –Strive to reduce economic inefficiencies –Start small Uncertainties important –Cost uncertainty is a major reason for reluctance

Further Reading Scott Barrett, Environment & Statecraft (Oxford University Press, New York, 2003) Scott Barrett, “Montreal vs. Kyoto,” in Inge Kaul (Ed), Global Public Goods (Oxford University Press, New York, 1999) [see also other contributors to this volume] Carlo Carraro (Ed), International Environmental Negotiations (Edward Elgar, Cheltenham, UK, 1997) Charles Kolstad, Environmental Economics (Oxford University Press, New York, 2000)