Effective Climate Agreements under Uncertainty

a Center for International Climate and Environmental Research, Oslo (CICERO) b Department of Economics, Appalachian State University, Boone NC We thank the International Foundation for Research in Experimental Economics (IFREE) for funding this research

Todd L. Cherrya,b and David M. McEvoyb

 

Basque Centre for Climate Change May 2015

A collective action problem

Collectively countries are better off reducing greenhouse-gas emissions, but individually they are better off left unconstrained. The non-cooperative outcome is socially undesirable. There is a need to design institutions to change the underlying incentives à International Agreements

 

   

By many metrics the Kyoto Protocol is/was a failure

Part of that failure can be attributed to free riding:

Non-participation Non-compliance

Participation and compliance

Countries must voluntarily join an agreement

… AND they must find it in their interest to comply with their commitments … AND this all has to happen under a great deal of uncertainty regarding the damages from climate change

         

Effective agreements

“the economic impact of climate change […] is the thorniest issue in climate-change economics” -  William Nordhaus

DICE (Dynamic Integrated Climate Economy)

A deposit-refund/performance bond system:

Signatories pay deposits upon ratification Deposits are paid back to compliant members

Who’s talking about this kind of institution/agreement?

Finus 2008 Gerber and Wichardt 2009 Hovi et al. 2012 McEvoy 2013; Cherry and McEvoy 2013 Hovi, Ward and Grundig 2014  

The institution we consider

Countries are uncertain about the benefits of emissions abatement when deciding whether to join the agreement When making emissions decisions the uncertainty is resolved (Kolstad 2007, JEEM)

Uncertainty

We design a series of public goods experiments to test the effectiveness of an agreement that requires up front deposits. We consider the effects of:

Uncertainty in the benefit of contributing Requiring less than full participation Low deposits

Objective

The Problem of Designing Effective Institutions

We lack the data required to test the effectiveness of different agreement architectures.  

The Role of Experiments

1.  Speaking to Theorists

2.  Searching for Facts

3.  Searching for Meaning 4. Whispering in the Ears of Princes

-Alvin Roth

The Role of Experiments

The laboratory as a “wind tunnel” -Vernon Smith

Kosfeld et al. 2009* McEvoy 2010* Tavoni et al. 2011 Dannenberg et al. 2011;2012* Barrett and Dannenberg 2012; 2013 Kolstad and Burger 2011* McEvoy et al. 2011*; Cherry and McEvoy 2013* Hovi et al. 2012 Miliniski et al. 2008 Vasconcelos et al. 2014

Experiments on collective action to provide global public goods

Baseline – voluntary contribution mechanism (VCM) each player in a group of 5 has 14 tokens and can contribution 0 to 10 to a public account

Marginal return (MPCR) = 0.60

Nash equilibrium = zero contributions, each player earn 14 tokens Social optimum = full contributions (50 tokens to public account) Average contribution = 4.17 tokens 1 token = $1

Full participation – certain benefits    Stage one: players decide simultaneously whether to join an agreement If all 5 players join the agreement then it enters into force. Members pay a deposit of 4 tokens and commit to contributing at least 8 tokens to the public account. If fewer than 5 join then an agreement does not form and everyone reverts to the baseline (VCM). Stage two: players decide their contribution amount. If members are compliant (when agreements form) they get the 4 token deposit back. Otherwise they lose it.

Stage two: if agreement forms: full compliance (all 5 players contribute 8 tokens) – each player earns 30 tokens

why? deposit > gains from violations if agreement fails: back to baseline – each player earns 14 tokens Stage one: since all players are critical they all join: full participation

Equilibrium (SPNE)

Full participation – uncertain benefits Stage one: when players decide whether to join an agreement they DO NOT know the MPCR. They know it will be either HIGH (0.80) or LOW (0.40) with a 50/50 likelihood. Note: expected MPCR is 0.60 Stage two: state of world is revealed, then same as before Note: Half of the time deposit amounts of 4 tokens will be TOO LOW to motivate compliance

Stage two:

When return is HIGH: full compliance (all 5 players comply and contribute 8) – each earns 36 When return is LOW: no compliance (all 5 players contribute zero and lose their deposit) – each earns 10

Stage one: all 5 (risk neutral) players join: full participation

Equilibrium (SPNE)

Partial participation – certain & uncertain benefits Stage one: players decide whether to join an agreement Like previous except that an agreement enters into force if at least 3 players join Stage two: same as before for members. Non-members make no deposits and have no commitments

Partial participation – certain & uncertain benefits Note: Agreements of size 3 are profitable: Compliant members earn = 14 – 8 + 0.60(24) = 20.4 Non-members earn = 14 + 0.60(24) = 28.4

Stage two: if agreement forms

When return is HIGH: full compliance (members comply and contribute 8 and earn 23.2 tokens) When return is LOW: no compliance (members contribute zero and lose their deposit and earn 10 tokens)

Stage one: two equilibria An agreement with 3 members and 2 nonmembers No agreement

Equilibrium (SPNE)

Low deposits – full participation Marginal return is certain = 0.60 Deposit amount = 2 SPNE:

Stage one: no participation

Stage two: no compliance Why? Benefit of violating = 8 * 0.40 = 3.20 Cost of violating = deposit = 2

Summary of group level predictions

Treatment   Members   Non-­‐members   Compliance   Avg.  PG  

Baseline   -­‐-­‐-­‐   -­‐-­‐-­‐   -­‐-­‐-­‐   0  

Full-­‐certain   5/5  (100%)   -­‐-­‐-­‐   100%   8  

Full-­‐uncertain   5/5  (100%)   -­‐-­‐-­‐   50%   4  

Part-­‐certain   3/5  (60%)   2/5     100%   4.8  

Part-­‐uncertain   3/5  (60%)   2/5   50%   2.4  

Full-­‐low  deposit   0/5  (0%)   5/5   0%   0  

Subgame perfect Nash equilibria for risk-neutral agents

3 sessions per treatment 20 subjects per session groups of 5, reshuffled for 20 periods Subjects participated in only one treatment Risk-elicitation exercise Stage one expectations regarding number of others joining

Protocol

Note: 1200 individual observations; 240 group-level observations per treatment

HERE  YOU  WILL  BE  REMINDED  WHETHER  AN  AGREEMENT  FORMED  AND  WHAT  YOUR  COMMITMENTS  ARE  (IF  ANY)  

HERE  IS  WHERE  YOU  ARE  INFORMED  WHETHER  THE  RETURN  IS  HIGH  OR  LOW  

Percent  that  Joined   Percentage  of  agreements  that  formed  

5  of  5  required  

Certainty   93.8%  

Uncertainty  

3  of  5  required  

Certainty   55.6%  

Uncertainty  

79.3%  

65.5%  

74.1%  42.0%  

78.8%  

63.3%  

Stage one results: participation and agreement formation

Percent  compliance  overall  

Percentage  Compliant  when  

Deposit  is  Sufficient    

Percentage  Compliant  when  

Deposit  is  Insufficient    

5  of  5  required  

Certainty   96.7%   96.7%   -­‐-­‐-­‐  

Uncertainty  

3  of  5  required  

Certainty   94.1%   94.1%   -­‐-­‐-­‐  

Uncertainty  

85.8%   96.4%   77.5%  

93.7%   97.8%   89.4%  

Compliance when agreements form

Average  ContribuIons  

Average  ContribuIons  

when  Agreements  Formed  

Average  ContribuIons  

when  Agreements  Failed  

VCM   4.17   -­‐-­‐-­‐   -­‐-­‐-­‐  

5  of  5  required  

Certainty   7.20  

Uncertainty  

3  of  5  required  

Certainty   4.33  

Uncertainty  

5.47  

5.87  

8.49  

5.86  

6.77  

7.85  

3.49  

3.77  

1.70  

2.53  

Crowding  out  Average contributions

Average  contributions  (non-­‐members)  

Average  ContribuIons  

Average  ContribuIons  by  

Members  

Average  ContribuIons  by  Nonmembers  

VCM   4.17   -­‐-­‐-­‐   -­‐-­‐-­‐  

3  of  5  required  

Certainty   5.86   8.27   0.883  

Uncertainty   6.77   8.42   2.27  

Leakage?  

ParIcipaIon   Agreement  FormaIon  

Compliance  when  

Agreements  Form  

Avg  ContribuIons  

Avg  ContribuIons  when  Agreements  

Failed  

Low  Deposit  

93%   69.4%   78.9%   6.01   3.60  

Compare  to  Nash  predic]on  of  0  

Low deposit treatment

With certain benefits, we observe high levels of participation, and high levels of compliance with agreements. Uncertainty has competing effects in terms of participation (though insignificant with conditional tests) We observe high levels of compliance even when it is costly for members to comply (i.e., deposits are set too low). Trying to cooperate and failing triggers non-cooperative behavior

Conclusions