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Cooperation to reduce developing country emissions
Suzi Kerr (Motu) and Adam Millard-Ball (McGill)
Motu climate change economics workshop, March, 2012
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The challenge• We need DCs to mitigate to meet targets• We want DCs to mitigate to lower costsBut• DCs have insufficient concern and capability /
capacity • Need to transfer resources• Existing instruments – e.g. offsets - have serious
flaws
How can we do better?
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Outline• Cooperation within a repeated game• Mitigation instruments• Challenges• Straw man• Future Research Directions
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Gains from cooperation
MICMDC
H
MBDC
MBIC
MBIC+DC
MCICMCDC MCIC+DC
Most gains to industrialised countryMost cost to developing country
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Can we achieve this?• Nash equilibrium (e.g. Barrett) very negative• More optimistic in a repeated game
– Experimental evidence that people are altruistic and conditional cooperators – states?
– Good monitoring, low discount rates make cooperation possible
– Some countries will lead to generate trustbut
– Bargaining will generate delay – difficult to identify bargaining space and agree on an equilibrium
• Need flexibility in cost sharing to find mutually beneficial deals.
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A Continuum of Mechanisms
6
Tradable creditsE.g. CDM
Grants and loansE.g. GEF
GHG reductions only
Integrated with cap-and-trade
Results based
Ex-post monitoring and payment
Broader development goals
No link to cap-and-trade
Effort based
Ex-ante assessment and payment
Non-financial approaches: technology transfer, capacity building
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Common Challenges
• Leakage• Adverse selection• Risk and moral hazard• Incomplete contracts/underinvestment• Negotiation• Integration with cap and trade
Most challenges apply to all instruments on the continuum, not just offsets
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Adverse Selection
• Information asymmetries between ‘regulator’ and offset provider combined with voluntary participation
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Adverse Selection
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Adverse Selection• Considerable evidence that adverse
selection is a major problem in CDM• Admissions by project developers• Manipulation of Internal Rate of Return• Non-credible claims about barriers• Implausibility of aggregate claims• Simulation / econometric models• Technology diffusion models
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Adverse Selection
Possible solutions:• Reduce private information• Conservativeness and discounting• Adjust the cap or fund size – or give
up and reward all• Scale up
• e.g. Domestic cap and trade in DC with binding cap
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Risk and moral hazard
baseline
response
emissions
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baseline
response
emissions
Baseline risk1. Improve baseline2. Allow baseline to
change• If fn(DC action) leads
to moral hazard
Moral hazard: when contract is insufficiently precise (possibly because of unobservable effort) so that what the parties explicitly agree to do in the contract is not exactly the intention of both parties.
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baseline
response
emissions
Response risk
3. Improve responses4. Reward actions rather
than emissions• Offset cost of actions• No incentive for
‘invisible’ actions
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Other risk management options5. Industrialised country direct investment
• IC takes some response risk• If brings extra resources makes response
larger and reduces relative baseline risk
6. ‘No loss’ baselines• Removes risk of absolute liability only• Makes effective price θp – where θ = prob
of reward• Response is lower and relative risk higher.
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Hold-up and underinvestmentEffective mitigation requires:
• long-term investment, • innovation, • policy change and • structural change
Once investments are made, the DC has little bargaining power during renegotiation
they will be unwilling to invest.
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Solutions to hold-up
1. IC makes direct equity investments in mitigation• Directly addresses under-investment• Bargaining becomes more balanced• Commitment is visible so less under-
investment• Has benefits for risk sharing also
2. Build IC credibility for cooperation
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Straw man1. Monitor (and model to assess effort)
2. Differentiate policies depending on the DC
For ‘strong’ countries – based on governance not income• Agree (bi- or multilaterally) combination of
target/pledge and investment package• Pay (in cash or tradable credits with
commitment to purchase) relative to target
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For ‘weak’ countries• If possible create regional or sectoral targets
with results-based agreements• Invest in policy, technology, capital and
infrastructure• Try to get maximum benefit for funds• Be clear about aid objectives• Do not link to cap and trade markets• Make graduation to national emissions
contracts attractive • Internalise carbon costs from IC end –
through capital and consumer markets
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Future Research DirectionsPotential
• Model realistic mitigation instruments rather than ideal
Leakage• Estimates of intertemporal leakage/persistence
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Future Research DirectionsRisk and additionality
• Better estimates of real uncertainty in emissions projections for DCs and the drivers of that uncertainty
• More out-of-sample tests of predictions
Integration with cap and trade• Evaluate costs and benefits of linking markets
under uncertainty
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Future Research Directions
Develop new mitigation instruments• More rigorous evaluation of actual mitigation
investments and policies in developing countries• Theory-based design and simulation of complete
policies under uncertainty• ‘Experiments’ in small countries/regions