The Economics of Kyoto and New Zealand

• Documented increases in global surface temperature over the 20th century.

• Recognition that international co-operation would be required to deal with this issue effectively.

• Previous voluntary agreements had proved ineffective.

Background to the Kyoto Protocol

• 55 Developed countries to reduce emissions levels of 5 GHGs to ~1990 levels by 2008-2012. ‘Harsh penalties’ for non-compliance.

• Developing countries exempt from emissions targets through first commitment period 2008-2012.

• Kyoto seen as the first step in a broader, long-term response to climate change.

Details of the Kyoto Protocol

• Climate change is a classic example of market failure. The emission of GHGs imposes external costs on other parties.

• Economic theory suggests intervention / regulation to internalise the problem. However, the externalities are international in this case.

• This is the basic problem with the Kyoto Protocol. The scale of the issue (temporal and spacial) renders the Protocol inherently unstable for several reasons…

Motivation for Kyoto Protocol

• The costs to developed countries of meeting their obligations will be substantial, and will be felt in the short-term.

• However, the benefits of doing so are far from certain.• The external need for action must be balanced with the

internal need for policies to be politically sustainable. Drastic measures will not be supported without tangible payoffs.

• The issue of opportunity costs is also important in the context of climate change uncertainty.

The Uncertainty Principle

• Under the Protocol, the emissions of GHGs within developing countries are not covered.

• There is thus an incentive for established firms to avoid emissions restrictions by relocating production processes from developed countries to developing countries.

• Such a situation would reduce output and employment in the developed country, but have no impact on total emissions. In fact, it may even lead to a higher level of emissions overall.

A Fair Deal?

The Best Response?• The KP is oriented towards a long-term decline in

GHG emissions.

• However, a more reasonable (economic) response might be a slow rise in emissions for several decades followed by a rapid reduction nearer the end of the century.

Role of technological change.

• However, this approach is not politically acceptable in the context of KP negotiations. This has been an sticking point with several important developed countries.

• New Zealand has been a long-term ‘supporter’ of Kyoto.

• Our obligation under the KP: reduce emissions to 1990 levels by 2008-2012.

• Complex trade-offs between environment and economy highlighted recently:- The use of negotiated greenhouse agreements (NGAs) with large-scale emitters, - the abolition of the livestock tax, - the scrapping of the carbon tax.

Difficulty of enacting climate change legislation at home...

New Zealand’s Role in the KP

The Prisoners’ Dilemma

• Ultimately, the Kyoto Protocol suffers all of the problems of a prisoners’ dilemma. While international co-operation is the best strategy for all, the incentives for each country to defect (‘free-ride’) are strong.

• This is especially so given the inability of third parties to monitor countries’ emissions and punish them for non-compliance.

Conclusion

• The Kyoto Protocol attempts to deal with the problem of negative externalities, on an international scale.

• To be effective, in the absence of a central international authority, such an agreement requires support across all nations.

• In reality, however, the divergent political and economic perspectives of the various parties make the negotiation and implementation of such an agreement difficult, prolonged and expensive. To be effective, the KP will likely need further work.