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FOIA Number: 2017-1095-F
FOIA
MARKER
This is not a textual record. This is used as an
administrative marker by the William J. Clinton
Presidential Library Staff.
Collection/Record Group:
Clinton Presidential Records
Subgroup/Office of Origin:
Council of Economic Advisers
Series/Staff Member:
Judson Jaffe
Subseries:
OA/ID Number:
20747
FolderID:
Folder Title:
Climate Change - Trading Models [1]
Stack:
Row:
Section:
Shelf:
Position:
S
20
6
1
3
MEMORANDUM
To:
Janet Yellen
From:
Joe Aldy and Randy Lutter
Date:
10/8/97
Subject:
Sensitivity of permit prices to alternative economic assumptions
How sensitive are estimated carbon permit prices to alternative assumptions about GDP growth,
autonomous energy efficiency improvement, and the opportunities for substitution across
technologies and fuels? A preliminary assessment of the effects of varying these assumptions
indicates that permit prices are unlikely to fall significantly. Since fuel switching is sensitive to
elasticities embedded in models, we conducted our analysis with energy and carbon outputs from
the Markal Macro and SGM models.
We find that for the permit price to be $30/ton in the SGM model, AEEI would have to equal
GDP growth. (This implies zero growth in energy use over the decade.) For the permit price to
be $30 in the Markal Macro model, AEEI would have to exceed GDP growth, implying that
energy use would have to fall over this period. The only recent decade when energy consumption
did not grow was from 1972 to 1982.
Methodology
We assume that the price of carbon varies linearly with the emissions reduction required under a
1990 in 2010 stabilization case relative to a no policy baseline.
CHICE
where Pₛ is the forecast price under stabilization under our approach, Pₘ is the model output
forecast price under stabilization, Cₛ is the change in carbon emissions required to achieve 1990
level in 2010 from a business as usual level (specified below), and Cₘ is the reduction in carbon
relative to the models' estimated business as usual.
Emissions reductions can be written as
S C/F
the product of a fuel switching factor, which is defined as the change in carbon under a
stabilization policy divided by the change in energy under this policy (both relative to a business
as usual projection for 2010) from a model, multiplied by the percentage change in energy
consumption. (Note that since the fuel switching parameter is driven by the price of carbon, we
cannot vary it exogenously.) The change in total energy use between the stabilization case and
business as usual in 2010 is determined by GDP growth and autonomous energy efficiency
improvement inputs.
As a starting point, we use the results from SGM and Markal Macro with the IAT assumptions
(AEEI = 1.25%, GDP growth of 2.06% and 1.91%) and permit prices of $81/ton and $145/ton in
2010. We use these to calibrate our spreadsheet. Note that our calibrations result in price
estimates that differ from the model results by 5.8% and 2.6% -- this likely is a function of using
rounded averages for GDP and AEEI. SGM generates a fuel switching factor of 1.5, while
Markal Macro assumes more fuel switching, so its factor is 1.64. We then calculated a set of
permit prices by varying GDP and AEEI over the 1995-2010 period. We varied annual GDP
growth by about 1.3% and 3% and AEEI by 0.7% and 1.75%. Note that the most recent GDP
growth rate projection is about 2.4%, and a survey of energy economists indicates that AEEI
likely falls between 0.5% and 0.7% (EIA employs a 0.9% energy efficiency improvement).
Results
The assessment of the permit prices with varying input assumptions indicates that permit prices
can vary significantly with the inputs. However, given that the IAT employed very optimistic
AEEI (1.25%) and moderate economic growth (~2%), the variations of inputs imply that permit
prices could easily be above the IAT forecast results. For example, assuming an AEEI of 0.9%
(consistent with the Energy Information Administration) and the present projected GDP growth
rate of 2.4%, the computed permit price with the SGM derived measure would be about $130/ton
while the Markal Macro derived measure would be about $250/ton. The chart on the next page
presents the estimated permit prices given the ranges of GDP growth and AEEI considered.
Low permit prices would require very slow growth and very optimistic AEEI. For example,
assume that over the next 13 years, the economy experiences 8 years of zero growth (e.g., a
prolonged recession) and five years of moderate growth (e.g., 2% per year). During this period,
assume that autonomous energy efficiency improvements occur at an annual rate of 0.9%. Under
this scenario, 2010 energy consumption would be roughly equal to 1995 energy consumption.
The price of a carbon permit in 2010 would still be about $30/ton with the SGM derived
measure, and nearly $60/ton with the Markal Macro measure.
Our sensitivity analysis indicates that prices can vary, but are more likely to vary upward relative
to the IAT results. Note however that we only varied GDP growth and AEEI. The nature of the
supply curve for emissions reductions also can affect the permit price. Modifying other
assumptions may generate different results.
1
As a check on our proportionality assumption, we did a second calibration of SGM using an AEEI of
1.0%, GDP growth of 2.0%, a fuel switching factor of 1.39, and a permit price of $108. This results in a predicted
price of $121, or 12% from the actual model result. Our assumption does not appear to be far off, but with higher
emissions reductions, our approach generates permit prices slightly larger than the model estimates. With smaller
emissions reductions, the error appears to be small. Note the attached chart that illustrates the marginal abatement
cost curve for emissions reductions in 2010.
Estimated Permit Prices Under Various GDP Growth and AEEI Assumptions
Derived from:
GDP Growth Rate
AEEI
Permit Price ($/ton)
SGM*
2.06%
1.25%
$86
SGM, Best Estimate
2.4%¹
0.9%¹
$128
SGM
1.25%²
0.7%
$69
SGM
1.25%²
0.9%
$55
SGM
1.25%²
1.25%
$31³
SGM
1.25%²
1.75%
$0³
Markal Macro*
1.91%
1.25%
$149
Markal Macro, Best Estimate
2.4%¹
0.9%¹
$250
Markal Macro
1.25%²
0.7%
$135
Markal Macro
1.25%²
0.9%
$108
Markal Macro
1.25%²
1.25%
$60³
Markal Macro
1.25%²
1.45%
$31³
Markal Macro
1.25%²
1.75%
$0³
* Calibration estimates: SGM model result is $81/ton, Markal Macro model result is $145/ton.
1: The 2.4% GDP growth rate corresponds to the Administration's most recent projection of
GDP growth. The 0.9% AEEI corresponds to the Energy Information Administration's
projection of AEEI over the next 20 years.
2: A growth rate average of 1.25% between now and 2010 would imply that during six of the
next thirteen years, the nation would experience a GDP growth rate of zero (e.g., a prolonged
recession) and annual GDP growth would average, during the remaining seven years, about 2%.
3: These estimates of permit prices assume that energy use remains flat or falls between now and
2010. An energy trend of this nature, over a period as long as a decade, has only occurred during
the 1970s and early 1980s as a result of the OPEC oil shocks.
Carbon Emissions Reductions Marginal Abatement Cost Curve, 2010
Carbon Price ($/ton)
200
150
100
Emissions reductions required
50
for stabilization at 1990 level
0
0
100
200
300
400
500
600
Emissions Reductions (MMTCE)
Model: SGM
9/18/97
Outputs
ID
Scenario
Model
Modelers
Target
Timetable
Trading
Permit
Revenue
Burden
BAU
Paper Tons
AEEI
Ramp-up
Time Path
PDV (5%;
GDP in 2010
Allocation
Recycling
Sharing
Emissions
or Corre-
2000-2050)
(deviation
Path
sponding
Foregone
from BAU)
Assumptio
Reductions
Consumption
a
SGM1
BAU
SGM,
Battelle
n/a
n/a
n/a
n/a
n/a
n/a
IAT
n/a
1.0
n/a
-->2050,
$121,650 billion
$9,185 billion
MAGICC
-->2100
(BAU
(BAU GDP)
(climate)
consumption)
SGM9
-10% of
SGM,
Battelle
-10% 1990
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$485 billion
$9,155 billion
1990 in
MAGICC
emissions
2010
part.
-->2100
(-$30 billion)
2010
level
(climate)
SGM8
-10% of
SGM,
Battelle
-10% 1990
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$980 billion
$9,149 billion
1990 in
MAGICC
emissions
2010
only
part.
-->2100
(-$36 billion)
2010
level
(climate)
SGM10
-10% of
SGM,
Battelle
-10% 1990
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$50 billion
$9,171 billion
1990 in
MAGICC
emissions
2010
part.
-->2100
(-$14 billion)
2010
level
(climate)
SGM36
1990 in
SGM,
Battelle
1990
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
yes
-->2050,
$195 billion
$9,179 billion
2020
MAGICC
emissions
2020
part.
-->2100
(-$6 billion)
level
(climate)
SGM39
1990 in
SGM,
Battelle
1990
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$230 billion
$9,172 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$13 billion)
level
(climate)
SGM3
1990 in
SGM,
Battelle
1990
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$225 billion
$9,172 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$13 billion)
level
(climate)
SGM18
1990 in
SGM,
Battelle
1990
stabilize in
Annex I
auction
lump-sum
LDC
TAT
PT
1.0
in 2005
-->2050,
$255 billion
$9,172 billion
2010
MAGICC
emissions
2010
stabilizes
-->2100
(-$13 billion)
level
at 2030 in
(climate)
2030
SGM,
Battelle
1990
stabilize in
Annex I
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$260 billion
$9,172 billion
SGM21
1990 in
2010
MAGICC
emissions
2010
BAU to
-->2100
(-$13 billion)
level
2030,
(climate)
equal per
capita in
2050
SGM17
1990 in
SGM,
Battelle
1990
stabilize in
domestic
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$740 billion
$9,164 billion
2010
MAGICC
emissions
2010
only
stabilizes
-->2100
(-$21 billion)
level
at 2030 in
(climate)
2030
no LDC
IAT
PT
1.0
no
-->2050,
$665 billion
$9,165 billion
SGM2
1990 in
SGM,
Battelle
1990
stabilize in
domestic
auction
lump-sum
2010
MAGICC
emissions
2010
only
part.
-->2100
(-$20 billion)
level
(climate)
SGM38
1990 in
SGM,
Battelle
1990
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$740 bilion
$9,164 billion
2010
MAGICC
emissions
2010
only
part.
-->2100
(-$21 billion)
level
(climate)
PT
1.0
in 2005
-->2050,
$740 billion
$9,164 billion
SGM20
1990 in
SGM,
Battelle
1990
stabilize in
domestic
auction
lump-sum
LDC
IAT
2010
MAGICC
emissions
2010
only
BAU to
-->2100
(-$21 billion)
level
2030,
(climate)
equal per
capita in
2050
SGM40
1990 in
SGM,
Battelle
1990
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$5 billion
$9,180 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$5 billion)
level
(climate)
9/18/97
ID
Scenario
Model
Modelers
Target
Timetable
Trading
Permit
Revenue
Burden
BAU
Paper Tons
AEEI
Ramp-up
Time Path
PDV (5%;
GDP in 2010
Allocation
Recycling
Sharing
Emissions
or Corre-
2000-2050)
(deviation
Path
sponding
Foregone
from BAU)
Assumptio
Reductions
Consumption
n
SGM4
1990 in
SGM,
Battelle
1990
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$5 billion
$9,180 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$5 billion)
level
(climate)
SGM22
1990 in
SGM,
Battelle
1990
stabilize in
worldwide
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$25 billion
$9,180 billion
2010
MAGICC
emissions
2010
BAU to
-->2100
(-$5 billion)
level
2030,
(climate)
equal per
capita in
2050
SGM19
1990 in
SGM,
Battelle
1990
stabilize in
worldwide
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$20 billion
$9,180 billion
2010
MAGICC
emissions
2010
stabilizes
-->2100
(-$5 billion)
level
at 2030 in
(climate)
2030
SGM35
1990 in
SGM,
Battelle
1990
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
yes
-->2050,
$660 billion
$9,172 billion
2020
MAGICC
emissions
2020
only
part.
-->2100
(-$13 billion)
level
(climate)
SGM37
1990'in
SGM,
Battelle
1990
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
yes
-->2050,
-$I billion
$9,183 billion
2020
MAGICC
emissions
2020
part.
-->2100
(-$2 billion)
level
(climate)
SGM6
1995 in
SGM,
Battelle
1995
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
CR
1.0
no
-->2050,
$380 billion
$9,175 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$10 billion)
level
(climate)
SGM5
1995 in
SGM,
Battelle
1995
stabilize in
domestic
auction
lump-sum
no LDC
IAT
CR
1.0
no
-->2050,
$425 billion
$9,174 billion
2010
MAGICC
emissions
2010
only
part.
-->2100
(-$11 billion)
level
(climate)
SGM7
1995 in
SGM,
Battelle
1995
stabilize in
worldwide
auction
lump-sum
no LDC
TAT
CR
1.0
no
-->2050,
$30 billion
$9,179 billion
2010
MAGICC
emissions
2010
part.
-->2100
(-$6 billion)
level
(climate)
SGM33
1995 in
SGM,
Battelle
1995
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
CR
1.0
yes
-->2050,
$410 billion
$9,176 billion
2020
MAGICC
emissions
2020
part.
-->2100
(-$9 billion)
level
(climate)
SGM32
1995 in
SGM,
Battelle
1995
stabilize in
domestic
auction
lump-sum
no LDC
IAT
CR
1.0
yes
-->2050,
$445 billion
$9,176 billion
2020
MAGICC
emissions
2020
only
part.
-->2100
(-$9 billion)
level
(climate)
SGM34
1995 in
SGM,
Battelle
1995
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
CR
1.0
yes
-->2050,
-$40 billion
$9,180 billion
2020
MAGICC
emissions
2020
part.
-->2100
(-$5 billion)
level
(climate)
SGM12
Peak in
SGM,
Battelle
2010 BAU
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
no
-->2050,
$55 billion
$9, 185 billion
2015
MAGICC
emissions in
2040
part.
-->2100
($0 billion)
2015; 1990
(climate)
level in 2040
SGM30
Peak in
SGM,
Battelle
2010 BAU
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$75 billion
$9,185 billion
2015
MAGICC
emissions in
2040
part.
-->2100
(0 billion)
2015; 1990
(climate)
level in 2040
SGM24
Peak in
SGM,
Battelle
2010 BAU
stabilize in
Annex I
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$75 billion
$9,185 billion
2015
MAGICC
emissions in
2040
stabilizes
-->2100
(0 billion)
2015; 1990
at 2030 in
(climate)
level in 2040
2030
9/18/97
ID
Scenario
Model
Modelers
Target
Timetable
Trading
Permit
Revenue
Burden
BAU
Paper Tons
AEEI
Ramp-up
Time Path
PDV (5%;
GDP in 2010
Allocation
Recycling
Sharing
Emissions
or Corre-
2000-2050)
(deviation
Path
sponding
Foregone
from BAU)
Assumptio
Reductions
Consumption
n
SGM27
Peak in
SGM,
Battelle
2010 BAU
stabilize in
Annex I
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$75 billion
$9,185 billion
2015
MAGICC
emissions in
2040
BAU to
-->2100
(0 billion)
2015; 1990
2030,
(climate)
level in 2040
equal per
capita in
2050
SGM11
Peak in
SGM,
Battelle
2010 BAU
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
no
I-->2050,
$235 billion
$9,185 billion
2015
MAGICC
emissions in
2040
only
part.
-->2100
($0 billion)
2015; 1990
(climate)
level in 2040
SGM29
Peak in
SGM,
Battelle
2010 BAU
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$270 billion
$9, 84 billion
2015
MAGICC
emissions in
2040
only
part.
-->2100
(-$1 billion)
2015; 1990
(climate)
level in 2040
SGM26
Peak in
SGM,
Battelle
2010 BAU
stabilize in
domestic
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$270 billion
$9, billion
2015
MAGICC
emissions in
2040
only
BAU to
-->2100
(-$1 billion)
2015; 1990
2030,
(climate)
level in 2040
equal per
capita in
2050
SGM23
Peak in
SGM,
Battelle
2010 BAU
stabilize in
domestic
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$270 billion
$9,184 billion
2015
MAGICC
emissions in
2040
only
stabilizes
-->2100
(-$1 billion)
2015; 1990
at 2030 in
(climate)
level in 2040
2030
SGM25
Peak in
SGM,
Battelle
2010 BAU
stabilize in
worldwide
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
-$3 billion
$9,185 billion
2015
MAGICC
emissions in
2040
stabilizes
-->2100
(0 billion)
2015; 1990
at 2030 in
(climate)
level in 2040
2030
SGM31
Peak in
SGM,
Battelle
2010 BAU
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
-$5 billion
$9,185 billion
2015
MAGICC
emissions in
2040
part.
-->2100
(0 billion)
2015; 1990
(climate)
level in 2040
SGM13
Peak in
SGM,
Battelle
2010 BAU
stabilize in
worldwide
auction
lump-sum
no LDC
TAT
PT
1.0
no
-->2050,
-$8 billion
$9, 185 billion
2015
MAGICC
emissions in
2040
part.
-->2100
($0 billion)
2015; 1990
(climate)
level in 2040
SGM28
Peak in
SGM,
Battelle
2010 BAU
stabilize in
worldwide
auction
lump-sum
LDC
IAT
PT
1.0
in 2005
-->2050,
$1 billion
$9,185 billion
2015
MAGICC
emissions in
2040
BAU to
-->2100
(0 billion)
2015; 1990
2030,
(climate)
level in 2040
equal per
capita in
2050
SGM15
+10% of
SGM,
Battelle
+10% 1990
stabilize in
Annex I
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$95 billion
$9,181 billion
1990 in
MAGICC
emissions
2010
part.
-->2100
(-$4 billion)
2010
level
(climate)
SGM14
+10% of
SGM,
Battelle
+10% 1990
stabilize in
domestic
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$460 billion
$9,174 billion
1990 in
MAGICC
emissions
2010
only
part.
-->2100
(-$11 billion)
2010
level
(climate)
9/18/97
ID
Scenario
Model
Modelers
Target
Timetable
Trading
Permit
Revenue
Burden
BAU
Paper Tons
AEEI
Ramp-up
Time Path
PDV (5%;
GDPin 2010
Allocation
Recycling
Sharing
Emissions
or Corre-
2000-2050)
(deviation
Path
sponding
Foregone
from BAU)
Assumptio
Reductions
Consumption
n
SGM16
+10% of
SGM,
Battelle
+10% 1990
stabilize in
worldwide
auction
lump-sum
no LDC
IAT
PT
1.0
in 2005
-->2050,
$1 billion
$9,184 billion
1990 in
MAGICC
emissions
2010
part.
-->2100
(-$1 billion)
2010
level
(climate)
+
MM1
BAU
Markal
DOE
n/a
n/a
n/a
n/a
n/a
n/a
IAT
n/a
~1.0
n/a
-->2025
n/a
$9,205 billion
(BAU GDP)
MM2
1990 in
Markal
DOE
1990
stabilize in
domestic
auction
lump-sum
no LDC
IAT
n/a
~1.0
n/a
-->2025
n/a
$9,137 billion
2010
emissions
2010
only
part.
(-$68 billion)
level
MM3
1995 in
Markal
DOE
1995
stabilize in
domestic
auction
lump-sum
no LDC
IAT
n/a
~1.0
n/a
-->2025
n/a
$9,152 billion
2010
emissions
2010
only
part.
(-$53 billion)
level
~1.0
n/a
-->2025
n/a
$9,197 billion
MM4
1990 in
Markal
DOE
1990
stabilize in
domestic
auction
lump-sum
no LDC
TAT
n/a
2020
emissions
2020
only
part.
(-$8 billion)
level
MM5
Peak in
Markal
DOE
2010 BAU
stabilize in
domestic
auction
lump-sum
no LDC
IAT
n/a
~1.0
n/a
-->2025
n/a
$9,201 billion
2015
emissions in
2040
only
part.
(-$4 billion)
2015; 1990
level in 2040
9/18/97
ID
Permit
Permit
Permit
Conc.
Conc.
Year Conc.
Change in
Change in
Emissions
Year
Intl. Trade of
Intl. Trade of
Date
File (h:\jaldy\)
Prices:
Prices:
Prices:
(ppmv) in
(ppmv) in
(550 ppmv)
Temp. (deg.
Temp. (deg.
Peak,
Returns to
Permits, U.S.,
Permits, U.S.,
Received
2010
2025
2050
2050
2100
Reaches 2x
C) from 1990
C) from 1990
mmtce
1990
2010
2050
Run
(Deviation
(Deviation
Pre-Ind. Level
in 2050
in 2100
(year)
(MMTCE), ($)
(MMTCE), ($)
from BAU)
from BAU)
(Deviation
(Deviation
(Deviation
from BAU)
from BAU)
from BAU)
SGM1
$0
$0
$0
502
711
2065
1.06
2.36
no peak:
n/a
n/a
n/a
08/21/97
cea90_~1.xls
2245
(2050)
SGM9
$91
$137
$238
481
645
2074
0.97
2.11
1637
never returns
-180,
-332,
08/21/97
cea90m_~1.xls
(-21)
(-66)
(+9)
(-0.09)
(-0.25)
(2005)
(-$16.4 billion)
(-$79.0 billion)
SGM8
$175
$304
$924
481
645
2074
0.97
2.11
1637
2010
n/a
n/a
08/21/97
cea90m_~1.xls
(-21)
(-66)
(+9)
(-0.09)
(-0.25)
(2005)
SGM10
$33
LES
$45
481
645
2074
0.97
2.11
no peak:
never returns
-332,
-845,
08/21/97
cea90m_~1.xls
(-21)
(-66)
(+9)
(-0.09)
(-0.25)
2060
(-$11.0 billion)
(-$38.0 billion)
(2050)
SGM36
$23
$86
$150
486
656
2072
0.99
2.16
no peak:
n/a
-180
-364
09/10/97
case20~1.xls
(-16)
(-55)
(+7)
(-0.07)
(-0.20)
1714
(-$4.14 billion)
(-$54.6 billion)
(2050)
SGM39
$41
$84
$149
486
656
2072
0.99
2.16
no peak:
never returns
-202,
-364,
09/10/97
case10~1.xls
(-16)
(-55)
(+7)
(-0.07)
(-0.20)
1714
(-$8.3 billion)
(-$54.2 billion)
(2050)
SGM3
$42
$84
$149
486
655
2072
0.99
2.15
no peak:
never returns
-202,
-364,
08/21/97
cea90_~2.xls
(-16)
(-56)
(+7)
(-0.07)
(-0.21)
1714
(-$8.5 billion)
(-$54.2 billion)
(2050)
SGM18
$39
$83
$150
478
565
2091
0.96
1.82
no peak:
never returns
-209,
-362,
08/27/97
case2.xls,
(-24)
(-146)
(+26)
(-0.10)
(-0.54)
1712
(-$8.2 billion)
(-$54.3 billion)
9/4/97 fax
(2050)
SGM21
$39
$83
$150
n/a
n/a
n/a
n/a
n/a
no peak:
never returns
-209,
-362,
08/27/97
case3.xls
1712
(-$8.2 billion)
(-$54.3 billion)
(2050)
SGM17
$108
$188
$582
476
564
2092
0.95
1.82
1550
2010
n/a
n/a
08/27/97
case2.xls,
(2000)
9/4/97 fax
(-26)
(-147)
(+27)
(-0.11)
(-0.54)
SGM2
$110
$191
$582
485
658
2072
0.99
2.16
1637
2010
n/a
n/a
08/21/97
cea90_~2.xls
(-17)
(-53)
(+7)
(-0.07)
(-0.20)
(2005)
SGM38
$108
$188
$582
484
656
2073
0.98
2.15
1550
2010
n/a
n/a
09/10/97
case10~1.xls
(-18)
(-55)
(+8)
(-0.08)
(-0.21)
(2000)
SGM20
$108
$188
$582
n/a
n/a
n/a
n/a
n/a
1550
2010
n/a
n/a
08/27/97
case3.xls
(2000)
SGM40
$16
$23
$33
486
656
2072
0.99
2.16
no peak:
never returns
-312,
-751,
09/10/97
case10~1.xls
(-16)
(-55)
(+7)
(-0.07)
(-0.20)
2101
(-$5.0 billion)
(-$24.8 billion)
(2050)
9/18/97
ID
Permit
Permit
Permit
Conc.
Conc.
Year Conc.
Change in
Change in
Emissions
Year
Intl. Trade of
Intl. Trade of
Date
File (h:\jaldy\)
Prices:
Prices:
Prices:
(ppmv) in
(ppmv) in
(550 ppmv)
Temp. (deg.
Temp. (deg.
Peak,
Returns to
Permits, U.S.,
Permits, U.S.,
Received
2010
2025
2050
2050
2100
Reaches 2x
C) from 1990
C) from 1990
mmtce
1990
2010
2050
Run
(Deviation
(Deviation
Pre-Ind. Level
in 2050
in 2100
(year)
(MMTCE), ($)
(MMTCE), ($)
from BAU)
from BAU)
(Deviation
(Deviation
(Deviation
from BAU)
from BAU)
from BAU)
SGM4
$16
$23
$32
486
655
2072
0.99
2.15
no peak:
never returns
-313,
-752,
08/21/97
cea90_~2.xls
(-16)
(-56)
(+7)
(-0.07)
(-0.21)
2102
(-$5.0 billion)
(-$24.1 billion)
(2050)
SGM22
$15
$23
$0
n/a
n/a
n/a
n/a
n/a
no peak:
never returns
n/a
n/a
08/27/97
case3.xls
2239
(2050)
SGM19
$15
$23
$110
478
565
2091
0.96
1.82
1883
never returns
-316,
-500,
08/27/97
case2.xls,
(-24)
(-146)
(+26)
(-0.10)
(-0.54)
(2040)
(-$4.7 billion)
(-$55.0 billion)
9/4/97 fax
SGM35
$71
$192
$582
484
656
2073
0.98
2.15
1550
2020
n/a
n/a
09/10/97
case20~1.xls
(-18)
(-55)
(+8)
(-0.08)
(-0.21)
(2000)
SGM37
$9
$24
$33
486
656
2072
0.99
2.16
no peak:
n/a
-246
-751
09/10/97
case20~1.xls
(-16)
(-55)
(+7)
(-0.07)
(-0.20)
2101
(-$2.21 billion)
(-$24.78
(2050)
billion)
SGM6
$74
$119
$202
483
648
2074
0.98
2.12
1637
never returns
36,
-122,
08/21/97
cea95_~1.xls
(-19)
(-63)
(+9)
(-0.08)
(-0.24)
(2005)
(+$2.7 billion)
(-$24.6 billion)
SGM5
$62
$131
$317
483
648
2074
0.98
2.12
1637
never returns
n/a
n/a
08/21/97
cea95_~1.xls
(-19)
(-63)
(+9)
(-0.08)
(-0.24)
(2005)
SGM7
$27
$32
$41
483
648
2074
0.98
2.12
no peak:
never returns
-131,
-593,
08/21/97
cea95_~1.xls
(-19)
(-63)
(+9)
(-0.08)
(-0.24)
2073
(-$3.5 billion)
(-$24.3 billion)
(2050)
SGM33
$57
$120
$203
482
648
2074
0.97
2.12
no peak:
n/a
20
-119,
09/10/97
case20~2.xls
(-20)
(-63)
(+9)
(-0.09)
(-0.24)
1599
($1.14 billion)
(-$24.16
(2050)
billion)
SGM32
$51
$131
$318
482
648
2074
0.97
2.12
1550
n/a
n/a
n/a
09/10/97
case20~2.xls
(-20)
(-63)
(+9)
(-0.09)
(-0.24)
(2000)
SGM34
$21
$33
$41
482
648
2074
0.97
2.12
no peak:
n/a
-122
-592
09/10/97
case20~2.xls
(-20)
(-63)
(+9)
(-0.09)
(-0.24)
2072
(-$2.56 billion)
(-$24.27
(2050)
billion)
SGM12
$0
$47
$155
491
n/a
n/a
1.02
n/a
1807
never returns
0, (n/a)
-367,
08/21/97
cea90_~1.xls
(-11)
(-0.04)
(2015)
(-$56.9 billion)
SGM30
$11
$56
$153
489
658
2071
1.00
2.17
1755
never returns
-5,
-367,
08/27/97
case6.xls,
(-13)
(-53)
(+6)
(-0.06)
(-0.19)
(2015)
(-$0.06 billion)
(-$56.2 billion)
9/4/97 fax
SGM24
$11
$56
$153
481
568
2089
0.98
1.84
1755
never returns
-5,
-367,
08/27/97
case4.xls,
(-21)
(-143)
(+24)
(-0.08)
(-0.52)
(2015)
(-$0.06 billion)
(-$56.2 billion)
9/4/97 fax
9/18/97
ID
Permit
Permit
Permit
Conc.
Conc.
Year Conc.
Change in
Change in
Emissions
Year
Intl. Trade of
Intl. Trade of
Date
File (h:\jaldy\)
Prices:
Prices:
Prices:
(ppmv) in
(ppmv) in
(550 ppmv)
Temp. (deg.
Temp. (deg.
Peak,
Returns to
Permits, U.S.,
Permits, U.S.,
Received
2010
2025
2050
2050
2100
Reaches 2x
C) from 1990
C) from 1990
mmtce
1990
2010
2050
Run
(Deviation
(Deviation
Pre-Ind. Level
in 2050
in 2100
(year)
(MMTCE), ($)
(MMTCE), ($)
from BAU)
from BAU)
(Deviation
(Deviation
(Deviation
from BAU)
from BAU)
from BAU)
SGM27
$11
$56
$153
n/a
n/a
n/a
n/a
n/a
1755
never returns
-5,
-367,
08/27/97
case5.xls
(2015)
(-$0.06 billion)
(-$56.2 billion)
SGM11
$0
$84
$559
489
n/a
n/a
1.01
n/a
1807
2040
n/a
n/a
08/21/97
cea90_~1.xls
(-13)
(-0.05)
(2015)
SGM29
$12
$99
$563
489
658
2071
1.00
2.17
1729
2040
n/a
n/a
08/27/97
case6.xls,
(-13)
(-53)
(+6)
(-0.06)
(-0.19)
(2015)
9/4/97 fax
SGM26
$12
$99
$563
n/a
n/a
n/a
n/a
n/a
1729
2040
n/a
n/a
08/27/97
case5.xls
(2015)
SGM23
$12
$99
$563
481
568
2089
0.98
1.84
1729
2040
n/a
n/a
08/27/97
case4.xls,
(-21)
(-143)
(+24)
(-0.08)
(-0.52)
(2015)
9/4/97 fax
SGM25
$4
$16
$111
481
568
2089
0.98
1.84
1893
never returns
-30,
-500,
08/27/97
case4.xls,
(-21)
(-143)
(+24)
(-0.08)
(-0.52)
(2030)
(-$0.1 billion)
(-$55.5 billion)
9/4/97 fax
SGM31
$4
$16
$33
489
658
2071
1.00
2.17
no peak:
never returns
-30,
-751,
08/27/97
case6.xls,
(-13)
(-53)
(+6)
(-0.06)
(-0.19)
2101
(-$0.12 billion)
(-$24.8 billion)
9/4/97 fax
(2050)
SGM13
$0
$14
$33
491
n/a
n/a
1.02
n/a
no peak:
never returns
0, (n/a)
-752,
08/21/97
cea90_~1.xls
(-11)
(-0.04)
2102
(-$24.8 billion)
(2050)
SGM28
$4
$16
$0
n/a
n/a
n/a
n/a
n/a
no peak:
never returns
n/a
n/a
08/27/97
case5.xls
2241
(2050)
SGM15
$17
$56
$113
489
662
2071
1.00
2.18
no peak:
never returns
-172,
-339,
08/27/97
casel.xls
(-13)
(-49)
(+6)
(-0.06)
(-0.18)
1824
(-$2.9 billion)
(-$38.3 billion)
(2050)
SGM14
$60
$128
$310
488
664
2071
0.99
2.18
1550
never returns
n/a
n/a
08/27/97
case1.xls
(-14)
(-47)
(+6)
(-0.07)
(-0.18)
(2000)
9/18/97
ID
Permit
Permit
Permit
Conc.
Conc.
Year Conc.
Change in
Change in
Emissions
Year
Intl. Trade of
Intl. Trade of
Date
File (h:\jaldy\)
Prices:
Prices:
Prices:
(ppmv) in
(ppmv) in
(550 ppmv)
Temp. (deg.
Temp. (deg.
Peak,
Returns to
Permits, U.S.,
Permits, U.S.,
Received
2010
2025
2050
2050
2100
Reaches 2x
C) from 1990
C) from 1990
mmtce
1990
2010
2050
Run
(Deviation
(Deviation
Pre-Ind. Level
in 2050
in 2100
(year)
(MMTCE), ($)
(MMTCE), ($)
from BAU)
from BAU)
(Deviation
(Deviation
(Deviation
from BAU)
from . BAU)
from BAU)
SGM16
$7
$16
$25
489
662
2071
1.00
2.18
no peak:
never returns
-219,
-643,
08/27/97
casel.xls
(-13)
(-49)
(+6)
(-0.06)
(-0.18)
2128
(-$1.5 billion)
(-$16.1 billion)
(2050)
MM1
$0
$0
n/a
n/a
n/a
n/a
n/a
n/a
no peak:
n/a
n/a
n/a
08/26/97
8_26runl.wk4
2066
(2025)
MM2
$148
$192
n/a
n/a
n/a
n/a
n/a
n/a
1586
2010
n/a
n/a
08/26/97
8_26runl.wk4
(2005)
MM3
$136
$146
n/a
n/a
n/a
n/a
n/a
n/a
1600
n/a
n/a
n/a
08/26/97
8_26runl.wk4
(2005)
MM4
$0
$198
n/a
n/a
n/a
n/a
n/a
n/a
1749
2020
n/a
n/a
08/26/97
8_26runl.wk4
(2010)
MM5
$0
$99
n/a
n/a
n/a
n/a
n/a
n/a
1767
2040*
n/a
n/a
08/26/97
8_26runl.wk4
(2015)
William D. Nordhaus
Yale University
Department of Economics
Tel: 203-432-3587
28 Hillhouse Avenue
Fax 203-432-5779
New Haven, Connecticut 06511-8268
June 20, 1997
see Figure 9
Dr. Jay Shogren
Council of Economic Advisers
Dear Jay,
This is a refined version of the earlier paper. The RICE-model simulations
have improved and do not look good for Rio-type schemes either from an
economic or political point of view.
book:
when things
Sincerely,
bite back
Rin
CLIMATE ALLOWANCES PROTOCOL (CAP):
COMPARISON OF ALTERNATIVE GLOBAL TRADABLE EMISSIONS REGIMES
William D. Nordhaus
June 17, 1997
Preliminary
Abstract
Recently, the U.S. government proposed an international emissions-trading
protocol to cope with the threat of global warming due to emissions from
greenhouse gases (GHGs). While such a proposal is superior to earlier approaches
(such as the country-specific emissions targets of the Rio Treaty or the Berlin
protocol), it leaves open a number of crucial questions. These include the
appropriate objectives, the distribution of emissions budgets among countries, a
mechanism to discover countries' perceived benefits from such an arrangement, as
well as a set of incentive and enforcement procedures.
This paper develops a Climate Allowances Protocol (CAP) that addresses
many of the outstanding issues. It is based on the view that the system should
balance costs against benefits, be economically efficient, and respect the
realpolitikal fact that sovereign nations must find it in their self-interest. The CAP
plan integrates climate policy with an underlying cost-benefit approach that
maximizes global incomes and allows countries to arrive at a level of the public
good that reflects an aggregation of individual country preferences.
Simulations of the efficiency and realism of the CAP plan using an updated
version of the RICE model indicate that it has major economic advantages, leads
to benefits for most participants, and has equivalent environmental benefits as
compared to current international proposals.
-1-
CLIMATE ALLOWANCES PROTOCOL (CAP):
COMPARISON OF ALTERNATIVE GLOBAL TRADABLE EMISSIONS REGIMES
William D. Nordhaus¹
June 17, 1997
Preliminary
1. Background and Motivation
Recently, the U.S. government proposed an international emissions-trading protocol
to cope with the threat of global warming due to CO 2 emissions from combustion of fossil
fuels and other greenhouse gases (GHGs). 2 While a market mechanism is superior to earlier
approaches (such as country-specific emissions targets), it leaves open a number of crucial
questions. These include the appropriate ultimate concentrations and emissions targets, the
distribution of allowable emissions among countries, a mechanism to discover countries'
perceived benefits from such an arrangement, as well as the issues of incentive and
enforcement procedures.
To date, there has been virtually no attention to the economic aspects of the design of
such a protocol, and surprisingly little attention to making the design consistent with sound
economic and political principles. This paper describes a regime (the "Climate Allowances
Protocol" or CAP) that takes into account current economic theory of public goods and
compares this approach with current proposals that are being discussed in government
circles. The basic philosophy here is that the system should balance costs against benefits, be
economically efficient, and respect the fact that the agreement must be among sovereign
nations and must be in the self-interest of participating nations.
Global warming poses especially nasty obstacles to reaching efficient and effective
policies. It is a public good over space and time in the sense that emissions in any place
affect climate everywhere and for centuries in the future. There is no obvious technological
fix. The scientific and economic uncertainties are sufficiently large that those who would be
harmed by policies can easily generate a smokescreen to confuse people by arguing that the
1
The author is A. Whitney Griswold Professor of Economics and on the staff of the Cowles
Foundation, 28 Hillhouse Avenue, Yale University, New Haven, CT 06520, USA.
2 See U.S. Department of State, U.S. Draft Protocol and Fact Sheet on Climate Change Proposal,
January 17, 1997.
-2-
scientific case is weak or trumped up. And the economic stakes are enormous, with the
present value of costs and future damages of many proposals likely to run in the hundreds of
billions of dollars annually. These features are exacerbated by the fact that there is no
obvious anchor or "focal" point for policy. In this respect, global warming differs from other
policies that have focal strategies, such as trade regimes (zero tariffs and trade barriers) or
nuclear non-proliferation agreements (no weapons or weapons-grade material). Without
focal policies, agreement is more difficult because reasoned disagreement is so easily
sustained.
While this discussion is aimed at the threat of greenhouse warming, I think of it as a
prototype for any important global economic public good. A global economic public good in
one for which there are huge numbers of economic agents in a large numbers of countries
and where the costs and benefits of action do not indicate any obvious focal policy or
technological fix. While global warming might or might not turn out to be a critical issue for
humanity or natural ecosystems, it is useful to think through how we might design a global
economic regime when and if a crucial global economic public good appears on the radar
screen. If you think global warming is a critical issue, this should interest you; if not, then
imagine a global economic public good that is critical and apply these principles there.
This sketch will begin with a summary of the mechanisms and then proceed to see
how it addresses the major design hurdles. It is meant only to sketch the major issues
because a full treatment would be longer than the tolerance of most mortals.³
2. The Thorny Issues of Regime Design
Current international proposals for limiting greenhouse gases (such as those set out in
the Rio Treaty or in the current U.S. proposal) are deeply flawed. They are based on arbitrary
historical benchmarks for emissions limitations and make no attempt to link the path of
emissions to any economic or environmental objective. They provide no incentives for
countries to join or to follow the rules once they have joined. It is not surprising that every
serious economic analysis of these proposals finds them highly inefficient.
3 This discussion will contain only a few references from the vast literature on the subject. An
excellent overview with a bibliography to most of the literature is contained in B.S. Fisher, S.
Barrett, P. Bohm, M. Kuroda, J.K.E. Mubazi, A. Shah, and R.N. Stavins, "An Economic Assessment
of Policy Instruments for Combatting Climate Change," Chapter 11 in James P. Bruce, Hoesung Lee,
and Erik F. Haites, Climate Change 1995: Economic and Social Dimensions of Climate Change,
Cambridge University Press, Cambridge, U.K., 1996, pp 397-439. Many of the legal principles are
laid out in Stewart???
-3-
What first principles would be look to in designing a regime that is economically
efficient and politically viable? The most important characteristics are the following:
The regime should be moderately efficient from an economic and administrative
point of view.
There must be positive incentives for countries to participate in the regime and to
fulfill their obligations.
The regime must contain a decision process which will induce countries to agree to
efficient levels of greenhouse gas reduction.
I believe that the proposal discussed below satisfies the first three criteria reasonably well.
The next three points are ones that are troubling and have no obvious solutions:
The regime must recognize that countries with inept or corrupt governments may
subvert the process or use it for personal gain.
The regime must not injure other international agreements, particularly international
trade agreements.
The decision process should be simple and familiar to countries.
3. The Basic Mechanism
The alternative regime considered here - which is called the Climate Allowance
Protocol (CAP) - would embed the price and quantity targets within a framework that
considers both environmental and economic objectives and sets the policies to maximize net
benefits. CAP proceeds by having a set of tradable emissions allowances or permits with
carbon price ceilings and floors. The major innovation is that the emissions limits and
carbon prices are derived from a dynamic cost-benefit analysis that incorporates all costs and
benefits of slowing climate change. The costs are estimated from engineering and economic
models, and will be tested in each accounting period. The benefits will be derived from a
public goods mechanism of participating countries.
Participant countries will be allocated a number of emissions permits for each budget
period. A major and fundamental difference between the CAP and current proposals is that
the emission baselines for individual countries are rolling targets rather than ones set on the
-4-
basis of an arbitrary historical benchmark. In addition, there are expectations that countries
will begin to participate as their economies develop. In CAP, countries will be expected to
make small emissions reductions when their per capita incomes reach an "entry-level
income" and to participate fully when their incomes reach "full-participation income."
In each budget period, the number of permits will be allocated according to a formula
that reflects each country's uncontrolled emissions and its ability to pay. Because carbon
prices are equalized across participating countries, there will be no need for tariffs or border
tax adjustments among participants. The incentive to participate - and sanctions against
violations - will come from import duties on the carbon content of imports of non-
participants into participating countries. Unlike current proposals, there is no need for
financial transfers among countries, which raise severe political complications. The balance
of the paper describes these points in detail.
4. The Trading Rules
The basic approach of the Climate Allowance Protocol is to have an agreement
among the participating countries to limit the total annual emissions of greenhouse gases.
The overall limitation will be allocated to individual countries, who will receive their basic
allowances of greenhouse gases. Nations will be allowed to buy, sell, barter, and borrow
other countries' allowances as long as all the rules are obeyed. The fundamental rule is that a
country's emissions shall not exceed the sum of its own allowances plus net purchases of
allowances from other countries.
Emissims:= Eij
e, & o
CAP would initially include "covered fuels," which comprise the consumption of
fossil fuels. For accounting purposes, consumption will be equal to domestic production of
fossil fuels plus net imports. For example, for the U.S., consumption would include
production of crude oil, natural gas, coal, as well as net imports of those fuels and net
imports of petroleum products such as gasoline. Consumption would exclude derivative
products such as petrochemicals, electricity, chemicals, as well as the fuels embodied in
manufactured products. In the CAP, because emissions limits are pegged to uncontrolled
?
emissions there are no significant distributional or efficiency impacts of the exact definition
CRUDE oil
Production
Natural gas
&
gasoline - imports
COAL
Imports
emissime limits pegged to uncontrolled emissions
-5-
of covered fuels. 4 There is a complication for imports from non-participants, which is
discussed later in the paper.
Each nation will be allowed to administer its emissions limitations in its own manner.
In a market economy, it would be natural to require that each producer or importer of
covered fuels purchase the requisite emissions allowances. For reasons discussed below, it is
recommended that governments auction or sell their allowances. We estimate that the cost of
X
the allowances would be shifted forward to consumers except for fuels that are highly price-
inelastic in supply.
5. Balancing Costs and Benefits in the Emissions Trading Regime
The fundamental philosophy of the CAP is that global emissions targets are chosen to
balance costs and benefits of emissions reductions. This approach is radically different from
current approaches in international negotiations (such as those under the Rio Treaty), which
have targets and timetables for emissions limitations with no rationale for the targets and
screnti
timetables. The Rio emissions limits are ones that occurred during a particular historical
economic
period in a particular country; they are easy to understand and explain. But they make no
ratural
sense; there is no link between the targets and timetables, on the one hand, and the economic
or environmental benefits. Need to L ink The target d timetribles
to econ. benefits.
The proposal here is to link the targets explicitly to economic and environmental
benefits through the use of dynamic cost-benefit analysis. The state of the art in cost-benefit
analysis of climate change are "integrated assessment" (IA) models, of which a wide variety
are currently available and in use.⁵ Most of the inputs into these models are of a scientific
and technocratic nature. Such inputs include parameters of the carbon cycle, engineering
and scientific data on global warming potential and carbon content of different fuels, and
4 The general principle is to define covered fuels in a manner that monitoring and enforcement costs
are minimized. For that purpose, covered fuels are production of fossil fuels plus net imports of fuels
and direct products. The only subtlety here is that consumption includes net imports, which will
require some careful thought to ensure consistency and efficiency. Under the principles for allocation
of allowances used here, the definition is of no importance for efficiency and is only of second-order
importance for distribution. The definition would have great importance under current international
proposals that have a fixed as opposed to a rolling base.
5 An excellent overview of Integrated Assessment models by lead author John Weyant and
collaborators is contained in Chapter 10 of James P. Bruce, Hoesung Less, and Erik F. Haites, eds.,
Climate Change 1995 - Economic and Social Dimensions of Climate Change, Cambridge
University Press, 1996.
-6-
1. optimizen M b/c
2.
optional emissims over 5 year.
3.
climate models. Two sets of non-technocratic data are, however, crucial for the results: the
costs of emissions reduction and the damages from (or willingness-to-pay to avoid) climate
change. Derivation of these will be described below.
The full output of the dynamic cost benefit analysis will be an "indicative plan"
for
global GHG emissions and carbon taxes. This indicative plan will be the basis of the overall
limits on emissions. For each (accounting period (say five years), countries will be allocated
emissions allowances whose sum equals the optimized emissions from the IA models.
The CAP mechanism relies on allocating emissions rather than carbon taxes because
there is no mechanism for allocating carbon taxes. But carbon taxes or prices are a central
part of the plan and will be introduced by having price ceilings and floors. Should emissions
limits within a budget period be tighter than expected because of model mis-estimates,
countries may buy emissions allowances at a ceiling price that is a premium (say, 150
percent) of the optimized carbon tax. Too-low prices will be ignored for the moment.
Deviations of prices or quantities from the levels projected in the IA planning models
for the budget period will automatically be corrected by model revisions for the next budget
period. This automatically incorporates a procedure by which the latest scientific and
economic information and revised national priorities will be incorporated into the prices and
quantities each period.
ADJUSTABLE TARgets given New intromation M costs d
6. Costs of Emissions Control
benefits
In our summary, we stated that the cost side of the cost-benefit analysis would be
automatically revealed in the emissions-trading market. We explain that point in this
section.
The revelation is seen most clearly for a private market economy. Suppose that the
price of an emissions permit is = $10 per ton of carbon. This means that firms can
produce output using covered fuels at a marginal cost of P+T or substitute inputs at a cost
of R. This implies that the marginal cost of reducing emissions is MC = R - P
The revelation of marginal cost in illustrated in Figure 1. The curves MC and MC²
are the marginal cost curves for emissions reductions in regions 1 and 2. The efficient
global cost-of-reduction curve is shown as MCᵀ. The vertical line at E' is the sum of the
emissions limitations of the regions, =
How ave
R=P+2
E' dE² E'
MC CF = P+2
chopsen?
MC oner = R
R-P=2
Firms in each regions will
purchase or sell permits to the
point where their MC of
Marginal cost, carbon tax
emissions reduction equals the
È'
E²
ET
permit price. The efficient
allocation is shown in Figure 1
at a permit price of τ*. At that
MC'
MC²
MC¹
price, region 1 buys permits
shown by the segment A, while
region 2 sells segment B. The
balancing condition is B + A =
A
0.
B
The key point to note is
7
that (for cost minimizing
E'
E²
E
2
È
ET
entities), the permit price will be
equal to the marginal cost of
Figure 1. Emissions cost curves in regions 1 and 2 and
emissions reductions for each
equilibrium price of permits
region. We will thus be able to
observe the marginal cost curve
for emissions reductions as individual entities make their decisions.
NGA FREIDA
7. Public Goods Mechanism
In contrast to cost of controls, the value of emission reductions (or averted damages
of climate change) cannot be determined by a market mechanism. Most of the damages will
be felt far in the future, and indeed even the "experts" have only the haziest notions about
what those costs may be and who will bear them. It is therefore necessary to design a process
whereby reliable estimates of different countries' willingnesses to pay can be derived.
Slowing harmful climate change is a global public good. Individual people, countries,
and generations make but a small contribution to slowing climate change, and this leads to
the possibility of free-riding, posturing, temporizing, and insincere statements of position.
On top of this intrinsic difficulty is the further complication that environmental policy is
largely in the hands of environmentalists and large companies, neither of which adequately
represents the interest of consumers. A final difficulty is that global warming involves
countries with highly divergent incomes and priorities. The major difficulty in any plan,
therefore, is to design a public goods mechanism that can find a tolerably good solution to
this very nasty public goods problem.
-8-
The mechanism proposed here responds to these problems by containing two stages.
The first stage is the constitutional stage. In this part, countries agree on the basic
framework of the process. This stage involves the choice of international instrument,
the accounting framework, the voting procedure, setting sanctions for non-
participation or infractions, and the legal ratification and amendment processes.
Given the long time horizon of the global warming problem, this stage effectively
operates behind a Rawlsean veil of ignorance because costs and particularly benefits
lie far in the future compared to most current investments and elections. Given the
nature of the public good, this stage is largely distributional and could easily lead to
protracted impasses.
The second stage contains the decision-administrative processes. Given the
constitution of the global warming agreement, heterogenous country preferences will
have to be aggregated into a single global level of emissions. Among the alternative
processes we suggest that a voting mechanism is likely to be the most fruitful.
Before discussing the constitutional and decision-administrative phases, some
background comments are necessary. The mechanism proposed here treats the massive
public goods problem by having nations serve as trustees of future generations and by
separating the costs today from the benefits in the future. The central idea is that countries
will vote a given "value" of reducing climate change (or the willingness to pay [WTP] to
reduce slow climate change). When the different values are aggregated, this will imply an
efficient level of emissions control and an associated carbon emissions price or carbon tax
today. None of these numbers will be a surprise to the countries who are voting on the
decision -- rather the final outcome will be the result of negotiations, persuasion,
recalibration, models runs, bargaining, and further negotiations until an agreed level of
control and carbon price is agreed upon.
It should be emphasized that the design of the public goods mechanism is both the
core of the proposal and its most problematic feature. While countries routinely use voting
mechanisms to decide upon national public goods, there are a very few supernational
examples of functional public goods mechanism. Those used by the European Union may
be the closest in nature to the proposal here.
8. The Constitutional Stage
Before voting, countries need to know how they will be "taxed" to pay for the public
good of slowing climate change. The mechanism outlined here presumes that nations are
-9-
likely to vote resources to emissions reductions primarily out of concern for the future rather
than because they believe that they are likely to be differentially affected. Nations which
have high willingness to pay and low discount rates will select higher control rates and
carbon emission prices than those who are primarily concerned with today's economic and
political issues.
The payment mechanism will start with a zero base of uncontrolled emissions. This
initial condition reflects the realistic fact of life that the status quo of doing nothing has a
privileged position under custom and international law. Starting from the status quo,
countries then pay according to both horizontal and vertical equity principles.
The horizontal equity principle is that countries with the same per capita incomes
should contribute proportionally to their current emissions. Assuming that price
elasticities of supply and demand are equal across countries, this implies that each
horizontally equivalent country shall receive permits that are a fixed fraction of
baseline or uncontrolled emissions; equivalently, this means that the expected
emissions reduction rate is equal for all horizontally equivalent country. If the
elasticities are equal, this implies that the cost of participating in and complying with
such a mechanism will be an equal fraction of national income for all countries that
have the same level of emissions.
The vertical equity principle would be that poor countries should be required to pay
less than rich countries. The formula that is explored below proposes a floor of
$5000 per capita (below which a nation would have no expectations of emissions
reduction) and a ceiling of $15,000 per person (above which a nation would be
expected to have full participation). The participation rate would then vary linearly
over that range. (I consider alternative progressivity schedules below.)
Formally, nation i would in accounted period t receive a number of emissions permits
equal to Eᵢₜ = E₀,ᵢ,t [(1-f(yᵢ,)µ,*] Here E₀,ᵢ,ₜ is the baseline or uncontrolled level of emissions
in period t, f(yᵢ) is a fraction running from 0 to 1 as a function of the country's per capita
income (yᵢ), and µ,* is the agreed target level of global emissions reduction for full
participants in period t. The actual level of global emissions reduction (µ,ᵃᶜᵗ) will be less
than the maximum level (µ,*) depending upon the degree of participation, the progressivity
of the vertical equity schedule f, and the degree of compliance. The total Σ 0,i,t,f(yᵢ) is the
amount of emissions that is subject to control and is called "reducible emissions."
The functioning of the mechanism is sketched in Figure 2. Estimates of the marginal
costs of emissions are based on engineering and economic models for the first period. In
-10-
seems
subsequent periods, more
reliable estimates will be
Marginal cost, carbon tax
obtained as countries begin
MCᵀ
reducing emissions and the
price of permits rises
above zero. The marginal
benefit function is derived
from the voting
mechanism described
below. These two
fundamental building
*
blocks are then used to
MBᵀ
generate the associated
allowable emissions [(1-
E*
Allowable emissions
µᵃᶜᵗ)E₀] and carbon permit
Emissions reduction
E₀
price (t*) as shown in
Figure 2.
Figure 2. Derivation of Allowable Emissions
In each accounting period, MCᵀ is estimated global marginal
With no
cost of emissions reductions while MBᵀ is the estimated
uncertainty, we could in
marginal benefit from emissions reduction derived from public
principle use either the tax
goods mechanism. This produces indicative carbon tax (t*)
or emissions limitations.
and allowable emissions E* = (1-u)E₀. Emissions reductions
In fact, the tax approach is
are then reallocated among countries according to region-
unworkable because it
specific MC curves and trade in permits as shown in Figure 1.
cannot be accurately
verified against a
background of other
policies (such as fuel taxes and coal subsidies). We therefore use the emissions limitation
approach as the most easily administered.
Given the uncertainty about the cost function, it is not sensible to ignore prices,
however. To avoid costly mistakes, it is suggested that a cap on carbon prices be set at some
premium (say 50 percent) over the estimated efficient price. (It may be possible to determine
the optimal premium from IA models.) The revenues from the sale of extra permits at the
premium price can be used as determined by the participating countries. For the case of
prices that fall below the estimated price, it is suggested that countries be allowed to "bank"
the excess permits for future use. We leave open the question of whether it would be useful
to have a fund for stabilization purposes.
-11-
9. The Voting Mechanism
The second stage of the process is the decision-administrative process in which the
revelation of the value of the public good is the essential issue. From an analytical
perspective, there are many proposals for mechanisms to facilitate revelation of preferences
for public goods. Most share the feature that they are "one-dimensional" in the sense that
agents vote for a level of public goods with a payment mechanism in place. The major
desideratum of an effective public goods mechanism is that it be incentive compatible. An
incentive compatible mechanism is one in which agents have an incentive to reveal their true
preferences.
There are a large number of potential ways that countries can decide upon a global
emissions-reduction target. 6 (a) One approach is simply to allow countries to decide on their
own. In the case of a Nash equilibrium where countries pursue only their own self-interest,
calculations indicate that the degree of emissions reduction would be minuscule. (b) The
Lindahl equilibrium asks countries to reveal their own individual prices and then sets the
NOT
global rate of emissions reduction to maximize global welfare. This is defective because
TRUE
countries have strong incentives to misstate their own preferences. (c) One approach is
simply allow countries to bargain until they reach agreement. Under the so-called Coase
theorem, this process would reach an efficient outcome. (The transactions costs here are
trivial relative to the economic costs and benefits.) While bargaining might reach a solution,
it seems more likely to get bogged down and to be subject to serious free riding by non-
participants. (d) A theoretically attractive approach is to use the Clarke-Groves mechanism.
In this approach, countries bid the value of different global warming strategies. They are
then taxed on the basis of their bids, with individual taxes calculated as the contribution of
each country to the net cost imposed on other countries. This mechanism has attractive
theoretical properties but is extremely complex, is far to intricate to explain to busy
politicians, and has never to my knowledge been implemented.
The approach proposed here is to use a voting mechanism. This has the advantage
that it is incentive compatible, is likely to come close to the efficient outcome (as long as
tastes are not too skewed), and is familiar to most people. The major disadvantage compared
to efficient public-goods mechanisms or bargaining is that it can impose significant costs on
those whose preferences deviate significantly from the mainstream. The basic idea is the
following:
6 I omit what seem fruitless or highly inefficient approaches like moral suasion and mandatory
technical standards. While these are highly popular among politicians and can sometimes be useful
supplements, they cannot form the core of an efficient and effective global public goods mechanism.
-12-
Voting Mechanism. The rate of emissions reduction is determined on the basis of the
globally aggregated willingness to pay for reducing climate change. The willingness
to pay is aggregated from the individual willingnesses to pay of different countries as
expressed by their votes. The individual willingnesses are then averaged across
participants on the basis of their reducible emissions.
In other words, the targeted emissions reduction is decided by voting of participants
in the plan. Each country expresses its willingness to pay (call it parameter wᵢ). The
individual countries willingnesses are then aggregated into a global willingness (Ω) by
averaging across the participants. Using the globally averaged willingness, then, we can
estimate the optimal emissions reduction and carbon tax or permit price.
To make this more concrete, we would define the willingness to pay parameter as the
annual willingness to pay to avoid the damages accompanying an equilibrium doubling of
CO₂ (or alternatively of a 3 degrees C warming). For example, a country might express a
willingness to pay 2 percent of GDP to prevent the equilibrium climate change associated
with a doubling of atmospheric CO2. To obtain the economically correct emissions
reduction, we would use the global average willingness to pay (Ω = Ew 2ᵢ) which is
obtained by averaging the individual country willingness to pay (wᵢ) by their shares of a
world income (xᵢ). Unfortunately, this presents serious incentive problems. Weighting WTP
by future incomes or total emissions (which is the appropriate measure of damage) would
allow rapidly growing countries or countries with low emission reductions fractions (f) to
free ride on current emitters.
To avoid free riding, we need to work with a variant of global WTP that is incentive
compatible. To do this, we weight each nation's expressed WTP by its share of reducible
emissions. This mechanism will give an unbiased estimate of current WTP if WTP is
uncorrelated with f(yⱼ). Weighted median voting is simple, robust to strategic distortions,
and prevents free riding:
Weighted medium vot;
Voting Mechanism. The voting mechanism in the plan would be to set the global
willingness to pay (Ω) equal to the median WTP. In this calculation, each unit of
reducible emissions would have an equal vote.
This mechanism is incentive compatible because there is no advantage for any country with
single-peaked preferences⁷ to vote anything other than its most preferred policy. To do
7 All studies of the damage from climate change indicate that countries have single-peaked
preferences with respect to the willingness-to-pay parameter.
-13-
otherwise would either have no effect if it did not change the outcome or would lower its
economic welfare if it did change the outcome.
Huh?
10. Calculation of Baseline Emissions
Baseline emissions play a critical role in the mechanism because determine the
economic interests of countries, affect the equity of the system, and have a major impact
upon incentive compatibility. One of the major flaws in current proposals (such as the Rio
Treaty or the 1996 U.S. emissions-trading protocol) is that they rely on historical emissions
to determine future allowances. This leads to growing inequities among countries and
provides a major roadblock to reaching an agreement. Under current proposals, countries
have emissions limits that are determined by their 1990 emissions levels. This penalizes
efficient countries (like Sweden) or rapidly growing countries (like Korea). It also gives a
premium to slow-growing countries (like Britain) while historically inefficient countries
(like Russia or Germany after unification) are rewarded by having too high a base. This
point can be illustrated as follows. We estimate that industrial CO₂ emissions for the U.S. in
2000-2009 will be about 1.64 billion tons of carbon per year. This represents a growth of 18
percent over the prior decade and an increase of about 20 percent over 1990 emissions.
Under current proposals, the U.S. would continue to live with its 1990 base in the indefinite
future. By contrast, Russia and Germany had emissions in 1994 of about 20 percent less than
1990 levels; they would receive large windfalls if the 1990 base were continued in the
future.
One of the major distinguishing features of the CAP is the calculation of each
country's base emissions.
Emissions base: Each country's emissions base would be equal to its uncontrolled
emissions in each budget period. This base would roll forward with the change in
each country's growth in output and population.
Under CAP, a country's base for reductions would be its uncontrolled level of emissions.
This base would then roll forward with each budget period. Countries that experience rapid
growth in their economies would not thereby be penalized, nor would countries receive
windfalls if they were historically inefficient. There definitely would be penalties from
higher emissions, but penalty would be proportional to the level of emissions rather than
some irrelevant historical experience.
Aside from better equity properties, the CAP approach of a rolling base also improves
the possibilities of reaching an agreement. As noted above, the CAP approach has the
-14-
feature that it would lead to a unanimous decision if countries have the same demand and
supply elasticities and the same damages from climate change (even if their growth rates
differ). The historical base has the unfortunate feature that the decision will depend upon the
growth rate; indeed, some countries (like Germany or Russia) might vote for very large
emissions reductions because they have such large emissions bases relative to their actual
emissions that this would drive up the price of their emissions allowances. Other countries
like the U.S. or Japan with growing emissions would find themselves with a severe relative
disadvantage. Indeed, they might even find that their optimum would be for negative
emissions reductions given their small base.
One problem with the rolling base is the possibility of countries having an incentive
to "ratchet" up their emissions in one period to increase the base in the next period. The
"ratchet effect" is a phenomenon observed in planning systems wherein individual agents
have incentives to increase spending (or in this case emissions) to increase their base for the
next planning period. Two points are important here. First, ratchet effects at the individual or explicit
firm level are minuscule because these agents have such a tiny impact upon national
collusion
emissions levels. Second, while the rolling base definitely attenuates the incentive to reduce
emissions at the country level, it does not give the wrong incentives as long as the real price
of allowances is not rising too rapidly. For constant emissions reduction rates, the ratchet
effect will be neutral when the carbon permit price is rising at the real interest rate. In the
more likely case where the carbon permit price is rising more slowly than the real interest
rate, the value to a country of an additional unit of emissions is negative. Again, note that the
ratchet effect applies only to countries, who receive permits, and not to individuals, who
must buy them. 8
11. Participation and Sanctions
Whatever the moral imperative to protect the planet, it seems likely that the present
costs will outweigh future benefits for most countries unless there is a cooperative
arrangement with sanctions on disinclined and wayward countries. One indication of the
tendency for free-riding is the estimate of the Nash-equilibrium. If countries take into
account only their own national interests, the control rates and carbon prices are likely to be
only a small fraction of the cooperative prices. Countries are unlikely to benefit from global
8 The present value of a unit of emissions in period t is -t, + ]. In this
expression, t, is the price of permits in accounting period t, µ₁ is the emissions control rate, r is the
real interest rate, and Θ is the length of the accounting period. This value is negative as long as the
permit price is rising less than the real interest rate and as long as the control rate is not falling. These
conditions are met in virtually all simulations.
-15-
warming policies for at least half a century.⁹ To make joining such an agreement for
individual countries worthwhile, therefore, not only must it impose reasonable, efficient, and
equitable burdens, but it must also impose serious and proportional sanctions on the
wayward and those who will not participate.
The most workable sanction would be carbon import duties levied on non-
participating and non-complying countries. There would be a number of different sanction
designs, but the simplest would be to have participating countries impose duties equal to the
current price of emissions permits times the carbon content of the imports of non-complying
countries into participating countries. For example, suppose that the U.S. were a participant
which persistently ignored its targets, which were a 10 percent reduction from a base
emissions of 1640 million tons of carbon. If the carbon emissions fee were $10 per ton, the
U.S. would face an import duty of that amount on its exports into participating countries. If
the U.S. exported one-fifth of its carbon output, then this would amount to duties of $10 X
0.2 X 1640 = $3.28 billion annually. The estimated annual cost of compliance is, by my
estimate, $0.85 billion, so it would definitely pay for the U.S. to comply rather than face the
import duties.
9
This point is clearly shown in W. Nordhaus and Z. Yang, "A Regional Dynamic General
Equilibrium Model of Optimal Climate-Change Policy," American Economic Review, September
1996.
-16-
The tradeoff is shown in
Figure 3 for a country
Marginal cost, carbon tax
considering whether or not to
join the plan. Compliance costs
MC
are area A under the marginal
cost curve. Noncompliance
would cost the country the
current carbon price times the
carbon content of exports,
shown as area B in Figure 3.
Carbon Exports
For small open economies,
relatively low emissions
reductions, and a large group of
B
participating countries, the
A
incentives to participate are
Required emissions reduction
Allowable emissions
E₀
likely to be quite strong.
Numerical calculations indicate
Figure 3. Country can comply by incurring costs of
that if the plan gets off the
emissions reductions of A. Non-complying countries face
ground by including more than
import duties on exports x carbon tax shown as area B.
half of countries, and if it is not
overly ambitious, the incentive
to participate would be
powerful except for very closed economies.
12. Corruption and Standards for Country Behavior
A mechanism for emissions trading contains a troubling paradox. While it imposes
present costs on countries by requiring them to reduce emissions, it also creates valuable
assets in the form of tradable emissions permits. Because limiting emissions creates a
scarcity where none previously existed, such a plan allows "green revenues" to flow to the
owners of the permits. The fact of wealth creation is troubling because the value of the
permits might be dissipated or used for corrupt purposes.
We can think of three different ways that the valuable permits could be allocated: (a)
auction, (b) building political consensus, and (c) corruption.
The optimal approach would be for governments to auction these permits and use
the revenues for worthwhile purposes -- to lower existing taxes, reduce budget
-17-
deficits, or expand valuable programs. Such use would be the fairest way to dispose
of the revenues and would enhance efficiency if the revenues were used to lower
other taxes. If the permits are auctioned and the revenues recycled, the net impact on
the country could be quite low.
Given political imperfections and the need to buy political support, a government
might give permits to those politically powerful groups who were adversely affected
by the plan. This occurred when the U.S. instituted its sulfur emissions-trading
regime, where the permits were allocated to polluters on the basis of historical
emissions. This approach is defective for a number of reasons: it overcompensates
polluters, it sets up terrible incentives for firms to ratchet up their emissions, and it
unnecessarily increases the deadweight loss of taxation. While the plan might strongly
recommend against such allocations, they would probably not constitute a violation of
the agreement.
The real difficulty arises with respect to non-democratic and corrupt regimes. In a
polar case, we might imagine a venal dictator who sells most of the permits (perhaps
to another country), pockets the proceeds, turns the screws tightly on the population
by severely limiting fuel imports, and moves the assets abroad to Riviera villas and
fine Bordeaux wines. This might even worsen the environmental condition of the
country and world by encouraging desperate foraging for firewood and increased
deforestation.
As examples, consider the cases of Iraq and Nigeria, each of which had emissions of
around 30 million tons of industrial CO₂ emissions in 1994. These could easily sell for $300
million or more each year of hard currency on the open market (or $3 billion annually if the
environmentalist plans were imposed). We would clearly want such countries to participate,
but we could not be confident that the revenues from the permits would not be used for
acquiring nuclear materials or bolstering Swiss bank accounts. To avoid antisocial activities,
we would probably impose conditionality requirements on the sale and use of emissions
permits; for example, renegade countries (however that is defined) might not be permitted to
sell permits to other countries. Of course, the more burdensome are the "ethical" restrictions
on the disposition of the permits, the less attractive participation becomes for countries, so
there is a delicate tradeoff here.
-18-
13. Simulations Using the RICE Model: The Setup
An important question is the relative efficiency of different climate-policy regimes.
For this analysis, I use an updated version of the "RICE model" of global warming 10 as
modified for this analysis. The RICE model is an integrated assessment model that includes
output, emissions, concentrations, climate change, and climate-change damages for a
number of world regions. The model uses the data for 13 regions of the world for the
estimates (U.S., Europe, China, India, Russia, and 8 other groups of countries). Most of the
parameters are from the original RICE model, but the data are updated to 1994 levels of
output and emissions. Using the model, we can calculate both the costs of compliance and
the benefits of slowing climate change in each region for the different policy proposals.
The model is then run for a number of different policy proposals.
A baseline is the "market" or "no-control" case where no climate policies are in
place.
The "optimal" policy corresponds to complete participation with lump-sum
redistribution.
There are three CAP regimes with three different schedules for participation. The
one described above is the "middle progressivity." There are in addition a regressive
and a more progressive plan.¹ 11
Finally, we investigate three proposals that correspond to plans that are currently under
discussion.
10 See Nordhaus and Yang, op. cit. for a complete discussion.
"The "middle progressive" CAP protocol assumes an entry-level income of $5000 per capital and
full-participation income of $15,000. More precisely, the percent participation (the f function) goes
linearly from 0 at a per capita income of $5000 to 100 percent at $15,000. Alternative progressivity
schedules have entry levels and full participation of ($10,000 and $20,000) for a "progressive"
approach and ($0 and $5000) for a "regressive" approach. For the simulations, we assume that there
is perfect compliance and that countries do not join ahead of schedule. We have simplified the
calculations by using the actual damage function rather than the median-allowable-emissions voting
function. In addition, we assume that the economic and technological variables are known with
certainty.
-19-
The Rio Treaty plan, which has emissions limits at 1990 levels for the OECD
region.
The U.S. proposal, or Rio limits with emissions trading among the OECD countries.
The "Berlin mandate," which follows the Rio Treaty but has 20 percent cuts in
emissions from 1990 levels starting in 2010 and does not allow trading.
The basic point is to investigate the comparative performance of the different regimes. That
is, what fraction of the benefits of the optimal control policy is captured by the emissions
regime, and how well do the different regimes attain the ultimate goal of slowing climate
change?
14. Empirical Results
The enclosed figures and tables show the major results. Figures 4 and 5 shows the
emissions under different plans. Figures 6 and 7 show the levels of concentration and
temperature change for the different proposals. There are significant reductions in emissions,
concentrations, and global temperature change in all the plans. Current approaches in the
Rio and Berlin plans do relatively well for the next century or so in terms of the
environmental objectives. In the longer run, they lag behind the CAP plans because they
have no mechanism to bring in big developing-country emitters in the future. Under the
CAP plans, all important countries (including India and China) incur reduction obligations
in the next century, so most emissions are covered relatively quickly.
While the environmental picture does not differ much among the different
approaches, there is an enormous difference in the economics. Figure 8 shows the net
benefits of the alternative plans. These measure the present value of control costs and
climate damages from 1990 on, in 1994 prices, discounted at a goods discount rate of 5
percent annually (the measurement convention is that costs are negative and measured
relative to no controls). Table 1 shows the basic data, with 1A showing the absolute levels
and 1B showing the impacts as a share of national outputs. The bottom half of the tables
show the impact relative to no controls for each region and for the world.
Two fundamental findings emerge from these simulations:
Economic turkey. The three current proposals on the international agenda (Rio, the
U.S. modification of Rio, and the Berlin protocol) have negative net benefits, and
substantial ones. These plans impose more than $100 billion of discounted costs for
-20-
the Rio approaches and $1 trillion of discounted costs for the Berlin approach. By
contrast, the CAP proposals all have positive global benefits. The Rio-based plans
suffer from limiting emissions to a small fraction of emissions, by having rigid
targets, and (except for the U.S. plan) by proscribing emissions trading.
Political clunker. The three Rio-style options are politically inept and cannot
survive the political market place in most democracies. They impose enormous costs
on the major participants - the high-income countries - and confer large benefits
on those who do nothing. The U.S. fares extremely poorly under all three of the
current proposals, including its own. These plans would be rejected by countries
acting in their self-interests. By contrast, the CAP plans have positive or at worst
small negative net benefits for all countries.
Figure 9 shows the distribution of gains and losses under two plans -- the middle
CAP plan and the U.S. plan of Rio targets with trading. This shows the difference in the
distribution of benefits of the different approaches. Figure 10 shows the carbon emissions
prices that are estimated for the different plans. The Rio-with-trading and the Berlin mandate
have extremely high emissions prices, reaching $100 quickly and heading north from there
very quickly. These carbon taxes are unrealistically high from an administrative and political
point of view. For example, the mine-mouth price of U.S. coal would rise by between 60 and
2000 percent over current prices depending on the time period and plan. The carbon tax in
the CAP plan, by contrast, starts around $6 per ton carbon and rises to $35 per ton by 2100.
Table 2 summarizes the economic impacts and efficiencies of the different
approaches relative to the optimal emissions reduction, which has a benchmark of 100
percent economic and environmental efficiency. The first two columns show the overall net
economic impacts. The three current proposals have benefit-cost ratios well below 1.
Trading improves the benefit-cost ratio of the Rio approach, but does not raise it anywhere
near unity. Focusing on the long term concentration and temperature effects in the middle
and right-hand columns, we see that - in addition to having much better economic
efficiency - the CAP plans also have better long-term environmental benefits than the Rio-
style proposals. Finally, Table 3 shows the impact of different plans on the United States.
The U.S. has little net gain or loss under the CAP plans but is a major loser under the Rio-
style proposals.
The most important conclusions that come from these simulations are (a) that current
approaches are no-starters in any negotiations in which countries take actions based on their
self-interest and the (b) current approaches are highly inefficient in their design. In short,
they are both bad politics and bad economics.
-21-
15. Conclusions
The CAP proposal described here is an attempt to flesh out a emissions-trading
proposal in the context of the global public good of global warming. In principle, it satisfies
most of the design criteria discussed in section 2. An efficient trading regime would have the
advantage of integrating policy with an underlying cost-benefit approach that maximizes
global incomes. Further, it would allow countries to arrive at a level of the public good that
reflects individual country preferences.
Model simulations indicate that the CAP plan would achieve between 40 and 75
percent of the potential economic benefit - and more than 96 percent of the long-term
environmental benefit - depending upon the time frame and progressivity schedule. These
compare with current proposals - such as the original Rio targets, the Berlin mandate, and
the U.S. modification of the Rio targets to allow emissions trading - which have less
favorable long-run environmental impacts and have significantly negative economic
impacts.
At the same time, we must register some important reservations about the proposal.
Many will think that the proposal to have sanctions linked to punitive import duties for non-
participants is a dangerous and unwarranted distortion of international trade. Additionally,
the mechanism for determining country preferences is complicated and may seem arcane to
political decision makers (although it is simple compared to many "familiar" issues such as
tax or real-estate law). And the treatment of inept and corrupt countries poses particular
problems. Most of these issues will, however, necessarily arise in any effective plan.
Notwithstanding these difficulties, the CAP proposal or some relative has the advantage of
being both economically advantageous and politically workable whereas all current
proposals are politically unrealistic and economically wasteful while conveying no
environmental advantage over the CAP plan.
-22-
Figure 4
25
Emissions
20
Emissions per year (bill t C)
15
10
Opt
Mkt
Rio
Mid
5
1980 2000 2020 2040 2060 2080 2100 2120 2140 2160
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Figure 5
Emissions
Alternative Plans
30
Optimal
Regress
25
Emissions (bill. tons C per year)
Middle
Progress
20
Berlin
Rio w/o trade
15
Rio w/ trade
Market
10
2100
2200
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Figure 6
Concentrations
Alternative Plans
3000
Optimal
2500
Regress
Concentrations (bill. tons C per year)
Middle
Progress
2000
Berlin
Rio w/o trade
1500
Rio w/ trade
Market
1000
2100
2300
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Figure 7
Temperature
Alternative Plans
6.5
Optimal
Regress
5.5
Middle
Temperature (degrees C)
Progress
4.5
Berlin
Rio w/o trade
3.5
Rio w/ trade
Market
2.5
2150
2350
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Figure 8
Net Economic Impact
Alternative Plans
200
0
Net impact (billions $, 1994 prices)
-200
-400
-600
-800
-1000
Optimal
Middle
Rio w/o trade
Berlin
Regress
Progress
Rio w/ trade
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Figure 9
Gainers and Losers
Alternative Plans
4
2
Gains or losses vs. market (.01 .01 % %)
0
-2
-4
MidProg
-6
Rio w/o Trade
-8
USA
Russia
China
India
OBE
Middle
Tiny
Japan
FSC
EU
Indo/Braz
BLU
Small
TOTAL
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Figure 10
Carbon Tax Rates in Different Plans
200
Optimum
$/tC
Rio W Trade
100
0
2000
2050
2100
06/17/97: 17:05:G:\Home Disk F\RES-CLIM\RICE\Rice97\NR#9 wb3
I able IA
Net Benefits of Alternative Trading Regimes
Billions of 1994 US dollars
Relative to No Global Warming
Indon/
USA
Japan
Russia
FSC
China
EU
India
Brazil
OBE
BLU
Middle
Small
Tiny
TOTAL
Market
-520.8
-336.4
-32.2
-39.3
-232.9
-695.4
-123.7
-228.7
-56.8
-104.2
-695.6
-260.0
-116.1
-3442
Optimal
-504.9
-318.9
-36.5
-40.7
-231.2
-661.3
-119.9
-214.7
-57.8
-98.6
-659.7
-246.5
-109.1
-3300
Regress
-520.1
-328.7
-29.3
-35.7
-218.5
-681.3
-115.7
-219.3
-51.2
-98.6
-678.6
-248.1
-110.0
-3335
Middle
-525.2
-332.7
-29.8
-37.6
-222.2
-689.5
-118.5
-220.6
-53.8
-100.2-
-675.1
-250.1
-111.6
-3367
Progress
-523.6
-333.8
-31.0
-38.2
-225.4
-690.9
-119.9
-222.4
-55.0
-101.2
-677.8
-252.5
-112.7
-3385
Rio w/o trade
-636.5
-396.1
-30.9
-37.8
-222.1
-759.1
-118.3
-219.2
-54.5
-100.0
-668.5
-249.5
-111.2
-3604
Rio w/ trade
-617.5
-382.1
-31.0
-37.9
-222.4
-757.1
-118.4
-219.4
-54.6
-100.1
-669.3
-249.8
-111.3
-3571
Berlin
-1057.3
-578.7
-29.7
-36.4
-213.3
-1064.5
-113.7
-210.6
-52.4
-96.1
-642.7
-239.9
-106.9
-4442
Relative to No-Control Solution
Indon/
USA
Japan
Russia
FSC
China
EU
India
Brazil
OBE
BLU
Middle
Small
Tiny
TOTAL
Market
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0
Optimal
15.8
17.4
-4.3
-1.4
1.8
34.1
3.8
14.0
-1.1
5.6
35.8
13.4
7.0
142
Regress
0.6
7.7
2.8
3.6
14.5
14.1
8.0
9.3
5.6
5.7
17.0
11.9
6.1
107
Middle
-4.4
3.6
2.4
1.7
10.8
5.8
5.2
8.1
3.0
4.1
20.5
9.9
4.5
75
Progress
-2.8
2.6
1.1
1.1
7.5
4.5
3.8
6.3
1.7
3.0
17.7
7.5
3.4
57
Rio w/o trade
-115.8
-59.8
1.3
1.5
10.8
-63.7
5.4
9.5
2.2
4.3
27.1
10.5
4.9
-162
Rio w/ trade
-96.8
-45.8
1.2
1.4
10.6
-61.7
5.3
9.3
2.2
4.2
26.3
10.2
4.7
-129
Berlin
-536.5
-242.3
2.4
2.9
19.7
-369.1
10.0
18.1
4.3
8.1
52.8
20.1
9.2
-1000
Item: Discounted GDP (trillions)
191.6
111.7
12.2
6.3
38.5
236.0
16.6
32.5
8.6
15.2
107.4
38.7
16.5
831.9
06/05/97: 11:59: F:\RES-CLIM\RICE\Rice97\NR#8.wb3
Table 1B
Net Benefits of Alternative Trading Regimes
Percent of Discounted GDP (x 100)
Relative to No Global Warming
Indon/
Stand.
USA
Japan
Russia
FSC
China
EU
India
Brazil
OBE
BLU
Middle
Small
Tiny
TOTAL
Dev.
Market
-27.2
-30.1
-26.4
-62.1
-60.4
-29.5
-74.5
-70.3
-65.9
-68.7
-64.7
-67.2
-70.5
-41.4
18.3
Optimal
-26.3
-28.6
-29.9
-64.2
-60.0
-28.0
-72.2
-66.0
-67.1
-65.0
-61.4
-63.7
-66.2
-39.7
17.3
Regress
-27.1
-29.4
-24.1
-56.4
-56.7
-28.9
-69.7
-67.5
-59.4
-64.9
-63.2
-64.1
-66.7
-40.1
17.0
Middle
-27.4
-29.8
-24.4
-59.5
-57.6
-29.2
-71.3
-67.9
-62.4
-66.0
-62.8
-64.6
-67.7
-40.5
17.3
Progress
-27.3
-29.9
-25.4
-60.4
-58.5
-29.3
-72.2
-68.4
-63.9
-66.7
-63.1
-65.3
-68.4
-40.7
17.5
Rio w/o trade
-33.2
-35.5
-25.3
-59.7
-57.6
-32.2
-71.2
-67.4
-63.3
-65.9
-62.2
-64.5
-67.5
-43.3
15.6
Rio w/ trade
-32.2
-34.2
-25.4
-59.8
-57.7
-32.1
-71.3
-67.5
-63.3
-65.9
-62.3
-64.6
-67.6
-42.9
15.9
Berlin
-55.2
-51.8
-24.4
-57.5
-55.3
-45.1
-68.5
-64.8
-60.8
-63.3
-59.8
-62.0
-64.9
-53.4
11.0
Relative to No-Control Solution
Indon/
Stand.
USA
Japan
Russia
FSC
China
EU
India
Brazil
OBE
BLU
Middle
Small
Tiny
TOTAL
Dev.
Market
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
Optimal
0.8
1.6
-3.5
-2.1
0.5
1.4
2.3
4.3
-1.3
3.7
3.3
3.5
4.2
1.7
2.4
Regress
0.0
0.7
2.3
5.7
3.8
0.6
4.8
2.9
6.5
3.8
1.6
3.1
3.7
1.3
1.9
Middle
-0.2
0.3
1.9
2.6
2.8
0.2
3.1
2.5
3.5
2.7
1.9
2.6
2.8
0.9
1.1
Progress
-0.1
0.2
0.9
1.7
1.9
0.2
2.3
1.9
2.0
2.0
1.6
1.9
2.1
0.7
0.8
Rio w/o trade
-6.0
-5.4
1.0
2.3
2.8
-2.7
3.2
2.9
2.6
2.8
2.5
2.7
3.0
-1.9
3.2
Rio w/ trade
-5.0
-4.1
1.0
2.3
2.7
-2.6
3.2
2.8
2.5
2.7
2.4
2.6
2.9
-1.5
2.8
Berlin
-28.0
-21.7
2.0
4.6
5.1
-15.6
6.0
5.6
5.0
5.4
4.9
5.2
5.6
-12.0
11.6
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Table 2
Efficiency
Economic
Temperature*
Concentrations*
Percent
Benefit/Cost
2150
2350
2100
2300
Regime
of Optimum*
Ratio**
Market
0
0.00
0.0
0.0
0.0
0.0
Optimal
100
2.88
100.0
100.0
100.0
100.0
Regress
75
2.87
96.2
99.6
93.0
99.8
Middle
53
2.87
82.7
98.5
70.7
98.8
Progress
40
2.87
61.9
96.3
46.3
96.5
Rio w/o trade
-114
0.44
67.7
41.0
73.8
44.2
Rio w/ trade
-91
0.49
69.4
40.1
72.8
43.6
Berlin
-704
0.20
97.3
51.9
111.5
55.5
* Percentage gain in net benefits, temperature, or concentrations as percent of optimal relative to market.
**Ratio of reduction in climate damages to abatement costs.
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Table 3
Costs and Benefits for the United States
[Billions of dollars, 1994 prices; costs and damages measures negatively*]
Relative to no controls
Costs
Benefits Net Benefits
Benefit-Cost Ratio
Market
0.0
0.0
0.0
na
Optimal
-14.0
29.9
15.8
2.13
Regressive
-20.8
21.4
0.6
1.03
Middle
-19.4
14.9
-4.4
0.77
Progressive
-14.3
11.5
-2.8
0.80
Rio w/o Trading
-131.9
16.2
-115.8
0.12
Rio with Trading
-112.3
15.6
-96.8
0.14
Berlin with 20 percent cuts
-571.1
34.6
-536.5
0.06
* Calculations are from the 1997 version of the RICE model. All numbers cover the period 1990
through 2400 and include the present value of the costs of compliance (including both resource costs
and permit purchases) and the climate damages discounted at a 5 percent discount rate back
to 1990 in 1994 prices. The "Costs" column measures the compliance costs and
the "Benefits" column measures the averted climate damage.
06/16/97: 07:52: F:\RES-CLIM\RICE\Rice97\NR#8a.wb3
DRAFT
On Stabilizing CO2 Concentrations -
Cost-Effective Emission Reduction Strategies
Alan Manne, Stanford University
Richard Richels, Electric Power Research Institute
February 25, 1997
This research results from our involvement in Stanford University's Energy Modeling Forum 14
Study. For presentation at the IPCC Asia-Pacific Workshop on Integrated Assessment Models,
the United Nations University, Tokyo, Japan, 10-12 March 1997. We are indebted to David
Chang and Robert Parkin for research assistance. We have benefited from discussions with
Sharmila Barathan, Jae Edmonds, Howard Gruenspecht, Eric Haites, Henry Jacoby, William
Nordhaus, Stephen Peck, Leo Schrattenholzer, John Weyant, Tom Wigley, and ZhongXiang
Zhang. Funding was provided by the Electric Power Research Institute. The views presented
here are solely those of the individual authors.
Abstract
With the adoption of the Berlin Mandate, developed countries are being
asked to set emission limits for the early decades of the next century. The size
of the reductions is currently the subject of international negotiations. This
paper is intended to contribute to the analysis and assessment phase leading
up to the adoption of new targets and timetables. However, we take a
somewhat different approach than that suggested by the Berlin Mandate.
Rather than focus exclusively on the next steps by developed countries, we
view the issue from the perspective of the Convention's ultimate objective,
the stabilization of atmospheric concentrations. We examine what might
constitute cost-effective strategies for limiting CO2 concentrations to
alternative levels. We then explore the implications for near-term mitigation
decisions and for long-term participation by the developing countries.
1. Introduction
In recent years, global climate change has become one of the most contentious
environmental issues facing the international community. The UN
Framework Convention calls for the "stabilization of greenhouse gases in the
atmosphere at a level that would prevent dangerous anthropogenic
interference with the climate system."¹ Yet the issue of what constitutes
"dangerous anthropogenic interference" is likely to remain the subject of
intense scientific and political debate for some time. For the present,
international negotiations must remain an ongoing process -- with ample
opportunities for learning and for midcourse corrections.
We are currently in the midst of one such review cycle. When initially put
forward at the "Earth Summit" in 1992, the Framework Convention called
upon developed countries to aim to return emissions to 1990 levels by the
year 2000. At the first meeting of the Conference of the Parties in 1995, these
commitments were deemed inadequate. As a result, the so-called "Berlin
Mandate" was adopted. This called upon developed countries to set
"quantified limitation and reduction objectives" for the post-2000 time
frame.²
Although the Berlin Mandate is explicit in its call for additional reductions, it
does not specify how large the reductions should be. Rather it specifies an
"analysis and assessment" phase to help inform the decision making process.
The deadline for new commitments is December 1997. A wide variety of
proposals have been put forward in anticipation of this deadline. These
proposals range from sharp cuts in near-term emissions to a more gradual
transition away from carbon-intensive fuels. The international research
community is actively engaged in trying to understand the environmental
and economic implications of these policy proposals.
This paper is intended to contribute to the process of analysis and assessment.
However, we take a somewhat different approach than that suggested by the
Berlin Mandate. Rather than focus exclusively on the next steps by developed
countries, we view the issue from the perspective of the Convention's
ultimate objective, the stabilization of atmospheric concentrations. We
examine what might constitute cost-effective strategies for limiting CO2
concentrations to alternative levels. We then explore the implications for
near-term mitigation decisions and for long-term participation by the
developing countries.
There are several reasons why a broader perspective is desirable. The
Intergovernmental Panel on Climate Change (IPCC) has demonstrated that if
CO2 concentrations were to be stabilized at any of the levels it examined, this
would require an eventual and sustained reduction in emissions to
substantially below current levels. 3 Developed countries cannot do the job by
themselves. Nor can the transition be accomplished overnight. Cost-effective
strategies will require both a global and a long-term perspective.
Any analysis of stabilization must confront the divisive issue of burden
sharing. With trade in carbon emission rights, emission reductions can be
made where it is cheapest to do so, regardless of their geographical location.
The allocation of permits will have little impact on the least-cost global
strategy. 4 It will, however, have profound affects on who pays. Consistent
with the Framework Convention, we adopt a burden sharing scheme that
initially places the onus on developed countries. We then discuss the
implications for international negotiations.
Economic analysis can play an important role in the climate debate. It can
help policy makers identify least-cost mitigation strategies from a global
perspective. In doing so, this helps to minimize the size of the overall
burden. It can shed light on the implications of alternative burden sharing
schemes at the regional level. Economic analysis, however, cannot tell us
how a given burden should be allocated. Fairness and equity issues must
necessarily be left to the international negotiation process.
Finally, we emphasize that our analysis is confined to mitigation costs. We
recognize that this is not the whole story, but it is an important part. Article 3
of the Framework Convention states that "policies and measures to deal with
climate change should be cost-effective so as to insure global benefits at the
lowest possible costs. Identifying least-cost mitigation strategies can free up
valuable resources for addressing alternative uses.
2. The model
The analysis is based on MERGE - a model for evaluating the regional and
global effects of greenhouse gas reduction policies. MERGE provides a bottom-
up representation of the energy supply system. For a given scenario, a least-
cost choice is made among specific technologies for the generation of
electricity and for the production of nonelectric energy. As fossil fuels (coal,
oil and gas) are exhausted, their prices rise and carbon-free alternatives
become more competitive. To allow for inertia in the energy supply system,
decline and expansion constraints are placed on existing and new
technologies, respectively.
A top-down perspective is taken for the balance of the economy. These sectors
are modeled through nested constant elasticity of substitution production
functions. The production functions determine how aggregate output
depends upon the inputs of capital, labor, electric and nonelectric energy. In
2
this way, the model allows for both price-induced and autonomous (non-
price) energy conservation and also for interfuel substitution. A "putty-clay"
formulation is used to allow for the lags in adapting to changes in energy
prices.
In MERGE, the savings and investment process is affected by intertemporal
and interregional forces. Each region is represented as though it maximizes
discounted utility (the logarithm of consumption) subject to an intertemporal
budget constraint. Its wealth includes not only capital, labor, and exhaustible
resources, but also its negotiated share in global carbon emission rights. With
this objective function, the costs of abatement are defined as the losses in the
discounted value of consumption associated with alternative carbon
constraints.
In previous versions of MERGE, the world was subdivided into five
geopolitical regions.⁶,⁷ The present version of the model, known as MERGE
3.0, divides the world into nine regions: 1) the USA, 2) OECDE (Western
Europe), 3) Japan, 4) CANZ (Canada, Australia and New Zealand), 5) EEFSU
(Eastern Europe and the former Soviet Union), 6) China, 7) India, 8) MOPEC
(Mexico and OPEC) and, 9) ROW (the rest of world). The further
disaggregation provides better alignment with the Annex 1/non-Annex 1
structure of the Framework Convention. It provides more details concerning
winners and losers under alternative burden sharing schemes, and it
distinguishes between the major oil importing and exporting regions.
Population trends for each region are taken as exogenous. Per capita incomes
are determined primarily by the rate of labor force productivity. Between 1990
and 2020, our projections are consistent with the conventional wisdom
median values of the International Energy Workshop poll. 8 For the world as
a whole, GDP growth is projected at an average annual rate of 2.5% between
1990 and 2100. It is assumed that there are ultimate limits to economic
growth, and that there will eventually be convergence between the per capita
incomes in the OECD countries and those in the rest of the world. Figure 2.1
shows our specific projections of per capita GDP in each of the nine regions.
MERGE is based on a general equilibrium formulation of the global energy-
economic system. This enables us to model trade in oil, gas and carbon
emission rights. The model does not, however, account for the effect of an
economic slowdown in one region on the full range of exports of another. It
may therefore be ignoring some important "spillover" effects. MERGE is not
designed to address short-run macroeconomic issues such as unemployment
and inflation. The employment level is exogenous, and there are
instantaneous adjustments to policy shocks. As a result, the model may
overlook some costly short-term dislocations.
3
Figure 2.1 Per Capita GDP
180
160
140
USA
120
OECDE
Thousands of US Dollars
Japan
100
CANZ
EEFSU
CHINA
80
INDIA
MOPEC
60
ROW
40
20
0
1990
2050
2100
2150
2200
Figure 2.2 Regional Carbon Emissions
20
18
16
14
12
Billion tons of carbon
non-Annex 1
10
EEFSU
OECD
8
6
4
2
0
2000
2010
2020
2030
2040
2050
2060
2070
2080
2090
2100
Figure 2.3 Total Primary Energy Use - Basecase
100%
80%
Carbon-free
60%
Gas
Oil
40%
Coal
20%
0%
2000
2010
2020
2030
2040
2050
2060
2070
2080
2090
2100
CO2 mitigation costs are determined by 1) the emissions baseline -- i.e., how
emissions are apt to grow in the absence of policy interventions, 2) the cost
and availability of alternative supply and demand-side options, and 3) the
magnitude of the CO2 constraint. For the present analysis, several supply and
demand parameters of the energy-economy submodel have been adjusted so
that the baseline tracks the IPCC IS92a⁹ scenario through the year 2100. Figure
2.2 shows carbon emissions for the OECD, EEFSU and non-Annex 1. Figure
2.3 shows the corresponding total primary energy use by fuel type.
Some observers have suggested that the exogenous specification of technical
change will overstate the costs of a carbon constraint. They argue that an
international carbon abatement agreement will automatically induce
innovations in carbon-saving technologies. We do not share their optimism
on the automatic nature of such innovations. (Consider, for example, the
history of both fission and fusion technologies.) We do believe, however, that
carbon constraints might speed up the process of technology diffusion.
MERGE 3.0 incorporates the notion of "endogenous technology diffusion".
Specifically, in the electric power sector, the near-term adoption of high cost
carbon-free substitutes makes it possible to introduce low-cost alternatives
more rapidly in the future. Upon request, the authors will supply computer
files that fully document the assumptions underlying the model.¹
3. Scenario design
We focus on three factors critical to determining the costs of stabilizing
concentrations at a particular level: the choice of global emissions pathway,
the degree of international cooperation and the burden sharing scheme. In
this section, we describe our assumptions with regard to each.
The global emissions path to stabilization. In 1994, Working Group I (WG1) of
the Intergovernmental Panel on Climate Change (IPCC) published a set of
concentration profiles for stabilizing atmospheric CO2 at 350, 450, 550, 650 and
750ppmv. 10 The purpose of their estimates was to illustrate what might be
required in terms of global CO2 emissions reductions in order to stabilize
concentrations at these different levels. Subsequently, Wigley, Richels and
Edmonds (WRE) published an alternative set of emission profiles for
achieving the WG1 concentration targets. 11 Although WG1 and WRE are
identical in terms of the prescribed stabilization levels and attainment dates,
they differ in the routes to stabilization (Figure 3.1a). The IPCC, while not
taking a position on the desirability of one set over another, published both in
their 1995 scientific assessment. 12
1
Contact [email protected]
7
Figure 3.1 Alternative Routes to CO₂ Stabilization
800
750ppmv
700
650
600
550
500
450
ppmv
400
300
WRE
200
WG1
100
o
1990
2050
2100
2150
2200
a) Alternative concentration profiles
20
IS92a
18
WRE
WG1
16
14
12
Billion tons of carbon
10
8
6
750ppmv
650
4
550
2
450
0
1990
2050
2100
2150
2200
b) Alternative fossil fuel emisson paths
Figure 3.1b shows the emission rates required to achieve stabilization via the
WG1 concentration profiles (the dashed lines) and the WRE concentration
profiles (the solid lines). The calculations were made using the Wigley carbon
cycle model. The WRE curves were constructed so that they would follow the
central IPCC "existing policies" or "baseline" emissions scenario (IS92a) in the
early years. The higher the stabilization target, the longer the adherence to
IS92a. In contrast, the WG1 curves depart from IS92a immediately.
WRE assert that concentration pathways with higher near-term emissions are
apt to have lower mitigation costs. They cite several economic studies that
have examined how mitigation costs might vary with the timing of emission
reductions.
13,14,15,16
These studies suggest that the time path to stabilization
may be as important as the concentration target itself in determining the
overall discounted costs. They conclude that emission pathways that provide
for a gradual transition away from fossil fuels are apt to be less expensive in
terms of mitigation costs.
The WRE analysis is primarily qualitative. While drawing upon other studies
to make their points, no explicit analysis is made of the mitigation costs
associated with either the WG1 or WRE pathways. This is the issue to which
we now turn. In this paper, we examine the costs of stabilizing concentrations
at 450, 550, 650, and 750ppmv, first following the WG1 emissions pathway and
then those suggested by WRE. In each case, we examine the costs to Annex 1
and non-Annex 1 countries under alternative burden sharing schemes.
The extent of international cooperation. A number of studies have shown
that the marginal costs of emissions abatement might vary considerably
among regions.¹⁷ This will be particularly the case in those periods when
emission reductions are confined to Annex 1 countries. Clearly, it is
inefficient to incur high marginal domestic abatement costs in Annex 1
countries when the marginal cost of emissions abatement is lower in non-
Annex 1 countries. It is equally clear that it would be unrealistic to expect the
non-Annex 1 countries to bear the burden of domestic reductions so as to
achieve a globally cost-effective result.
This suggests opportunities for efficiency gains through various forms of
"joint implementation". This could be done on a bilateral project-by-project
basis during the earlier years of an international agreement. Over the long
term, however, it is more promising to explore market mechanisms such as a
system of international allocations of tradable carbon emission rights. Here
we first examine mitigation costs when emission reductions are confined to
the region of origin. We then calculate the benefits from international
cooperation using trade in emission rights as a proxy for other forms of
cooperative mechanisms with side payments.
9
When we assume that reductions take place wherever it is cheapest to do so
(regardless of the geographical location), we refer to this as "interregional" or
"where" flexibility. When there is a choice in the timing of emission
reductions, we refer to this as "intertemporal" or "when" flexibility.
The burden sharing rule. Region-specific mitigation costs will also depend
upon how emission reductions are allocated among regions. Consistent with
the Berlin Mandate, we assume that the burden will fall on Annex 1
countries during the initial decades of an agreement. During this period,
Annex 1 countries would be required to limit their emissions to amounts
proportional to their 1990 levels.
Even if the Annex 1 countries were to reduce their emissions to zero, this
would not be sufficient to limit global concentrations. Eventually, the non-
Annex 1 countries will also have to limit their emissions. The ultimate
concentration target will affect the date at which these non-Annex 1 countries
must begin to participate in a global agreement. The more ambitious the
target, the sooner they will have to participate in such an agreement. Once the
non-Annex 1 countries do agree to a constraint, however, it is plausible to
assume that there will be a gradual transition to equal per capita emission
rights. (For one such scheme, see Table 3.1.)
Table 3.1 Structure of Burden Sharing Scheme
Concentration target
Date at which non-
Date by which transition
(ppmv)
Annex 1 countries must
to equal per capita
begin to limit emissions
emission rights is
achieved
450
2020
2040
550
2030
2050
650
2040
2060
750
2050
2070
With "where" flexibility, global mitigation costs are independent of the
burden sharing scheme. That is, reductions will take place wherever it is
cheapest to do so regardless of the geographical location. This is not the case,
however, when emission reductions are restricted to the region of origin.
With this type of restriction, the burden sharing scheme will affect both the
global and the regional costs.
10
4. Global costs of stabilization at 550ppmv
Mitigation costs are incurred when the imposition of a carbon constraint
leads to a reallocation of resources from the pattern that would be preferred in
the absence of the constraint. A carbon constraint will lead to more expensive
conservation activities and to fuel switching. There are changes in both
domestic and international prices. In most cases, these forced adjustments
lead to a reduction in economic performance. The tighter the constraint, the
greater the effect.
With MERGE, we can calculate how mitigation costs vary with the choice of
concentration profile. At the present time, there is little consensus on what
constitutes an appropriate concentration target. There is even less consensus
on the choice of a pathway to stabilization. We shall begin by focusing on a
concentrations target of 550ppmv -- approximately twice the preindustrial
level. Later, we will explore the implications of adopting alternative
concentration targets.
Figure 3.1b shows two sets of emission pathways for stabilizing concentrations
at 550ppmv. The burden sharing rule (Table 3.1) will determine how
emissions might be apportioned between regions. The results are
summarized for three broad groups of countries: 1) the OECD (USA, Western
Europe, Japan, Canada, Australia and New Zealand), 2) EEFSU (Eastern
Europe and the former Soviet Union) and 3) developing countries. In the
language of the Framework Convention, the first two groups are described as
Annex 1 countries. All others (the developing countries) are non-Annex 1
countries.
Figure 4.1 shows the implications of the burden sharing rule for these three
regional groupings. The figure provides some insight into both global and
regional costs. Under the WRE scenario, Annex 1 countries have some room
for emissions growth, at least during the early decades of the 21st century.
This is not the case, however, under the WG1 scenario. Here, Annex 1
emission reductions must begin immediately. This decline would be
inconsistent with post-1990 trends in all but a few countries.
Figure 4.2 compares mitigation costs over the 21st century. Consumption
losses are expressed in constant dollars, discounted to 1990 at 5% per year.
Notice that costs are considerably lower for the WRE pathway. There are
several reasons why this turns out to be the case. A concentration target
defines an emissions budget, i.e., an allowable amount of carbon to be
released between now and the date at which the target is to be achieved. A
cost-effectiveness analysis is focused upon how this global budget might be
allocated over time.
11
Figure 4.1 Alternative Emission Pathways for Stabilizing
Concentrations at 550ppmv
10
9
8
Total
7
6
non-Annex 1
Billion tons of carbon
5
4
3
X
2
OECD
1
EEFSU
0
1990
2050
2100
2150
2200
a) WG1
10
9
Total
8
7
6
Billion tons of carbon
5
non-Annex 1
4
3
X
2
OECD
1
EEFSU
0
1990
2050
2100
2150
2200
b) WRE
Figure 4.2 Regional Costs of Stabilizing Concentrations at 550ppmv
-- discounted to 1990 at 5%
10
8
non Annex-1
6
EEFSU
$
OECD
4
Trillions of dollars
2
0
w/o
w/o
"where"
"where"
"where"
"where"
flexibility
flexibility
flexibility
flexibility
-2
WG1
WRE
-4
Shifting emission reductions into the future provides valuable time for: 1)
adapting the energy using and energy producing capital stock, 2) developing
low cost substitutes to carbon intensive fuels, and 3) removing carbon from
the atmosphere via the carbon cycle. In addition, with the economy yielding a
positive return on capital, future reductions can be made with a smaller
commitment of today's resources. For a more detailed discussion of these
factors, see ref. (11).
Figure 4.2 also estimates the benefits from international cooperation.
Without "where" flexibility, the immediate emission reductions are confined
directly to the Annex 1. The more countries that participate in an
international agreement, the greater become the opportunities for cost-
effective trades. It then becomes possible for countries with high marginal
abatement costs to purchase emission rights from countries with low
marginal abatement costs.
From a global perspective, combining "where" flexibility with a more gradual
transition away from fossil fuels substantially reduces the present value of
mitigation costs. It turns out that there can be cost reductions as high as 90%
when we combine both types of flexibility. (Compare the leftmost to the
rightmost bar in Figure 4.2.) The discounted cost savings to the international
community appear to be of the order of trillions of dollars over the 21st
century. This is consistent with earlier studies which focused exclusively on
18,19
near-term targets and timetables.
Table 3.1 describes a burden sharing rule that is particularly favorable to the
non-Annex 1 countries during the early decades of the next century. This is
why the mitigation costs are lowest for non-Annex 1 countries under the
WG1 pathway when we allow for "where" flexibility. Indeed, the WG1
emission constraints creates a sufficiently high price for emission rights and
high wealth transfers during the early decades of the coming century so that
the non-Annex 1 countries are actually better off in the presence of a carbon
constraint than in its absence. This particular result should not, however,
obscure the fact that from a global perspective, costs are far lower under the
WRE pathway.
5. Annual losses when stabilizing concentrations at 550ppmv
Figure 4.2 summarizes abatement costs in terms of discounted present value
-- summing over all time periods. Additional insights can be gained by
looking at how losses might evolve over time. In MERGE, we adopt
consumption as our welfare measure. Relative impacts are more apparent
when we measure annual losses in percentage rather than absolute dollar
terms.
14
Figure 5.1 International Price of Crude Oil
70
60
50
40
$/barrel
30
reference case
20
WRE ("where" flexibility)
WRE (w/o "where" flexibility)
WG1 ("where" flexibility)
10
WG1 (w/o "where" flexibility)
0
2000
2010
2020
2030
2040
2050
c) non-Annex 1
2.
1.
2100
0602
2080
2070
0902
2050
2040
2030
OTT
2019
0
-
2
% loss
C
,
S
9
&
EEFSU (q
2-
1.
2100
0602
0802
2070
2060
2050
2040
2030
2020
2010
2000
0
*
1
=
% loss
C
,
S
9
L
OCCD (e
2-
1.
2100
2090
0809
2070
0902
2050
2040
2030
2020
2010
2000
0
*
-
2
% loss
E
,
WRE ("where" flexibility)
WRE (w/o "where" flexibility)
S
WG1 ("where" flexibility)
WG1 (w/o "where" flexibility)
9
L
Figure 5.2 Annual % Consumption Losses
In order to explain the pattern of annual losses, it is first necessary to say
something about the impact of a carbon constraint on world oil prices. A
carbon constraint would have roughly the same consequence as
monopsonistic cartel behavior on the part of oil importing nations.
Figure 5.1 shows the international price of oil for the reference case and under
the alternative pathways for stabilizing concentrations at 550ppmv. Note that
oil prices are quite sensitive to the pathway to stabilization. With a tight near-
term constraint, there is a drop in the international demand for crude oil.
This has a dramatic effect on oil prices. There can be a differential of as much
as $20 per barrel between the reference and the WG1 cases. This has important
implications for the costs of a carbon constraint to both oil exporting and oil
importing countries.
Figure 5.2 compares annual welfare losses across scenarios for each of the
three broad regional groupings. Under WG1, the Annex-1 countries must
begin reducing emission immediately. Losses are highest when there is no
opportunity for trading emission rights. Losses rise to more than 3% and 6%
of annual consumption for the OECD and EEFSU, respectively. As a major
importer of oil, the OECD benefits from the decline in world oil prices. Hence,
its losses are partially mitigated. EEFSU, on the other hand, is a substantial
exporter. As a result, it will be adversely affected by a drop in world oil prices,
and this compounds its losses from a near-term carbon constraint.
The non-Annex 1 region consists of both oil exporting and oil importing
countries. Under the burden sharing scheme described in Table 3.1, the WG1
proposal leads to substantial net benefits in the early years, particularly with
"where" flexibility. A tight near-term global emissions constraint would
create a large demand for emission rights in Annex 1 countries. Since non-
Annex 1 countries have carbon allocations up to their baseline emissions, it is
in their interest to engage in domestic abatement, and to sell some of their
rights to Annex 1 countries.
With the parameters employed in this version of MERGE, there is a net
benefit to the non-Annex 1 countries, even without "where" flexibility. The
oil importers gain more than the oil exporters lose from the decline in world
oil prices. Eventually, however, the region will become a net loser unless it is
able to sell emission rights to Annex 1 countries.
6. The least-cost mitigation pathway -- 550ppmv
The WG1 emission pathways were meant to be purely illustrative. No
attempt was made to determine whether they represented an efficient
transition away from fossil fuels. WRE, on the other hand, drew upon the
insights of earlier studies in constructing their emission pathways. They
17
Figure 6.1 Alternative Emission Pathways for Stabilizing Concentrations at 550ppmv
20
18
16
14
baseline
least-cost
12
Billion tons of carbon
WG1
WRE
10
8
6
4
2
0
1990
2000
2010
2020
2030
2040
2050
2060
2070
2080
2090
2100
Figure 6.2 Global Costs of Stabilizing Concentrations at 550ppmv
-- discounted to 1990 at 5%
3.5
3
2.5
2
Trillions of dollars
1.5
1
0.5
0
WG1
WRE
least-cost
Figure 6.3 Value of Carbon Emission Rights with Alternative Pathways
for Stabilizing Concentrations at 550ppmv
300
250
200
$/ton of carbon
WG1
150
WRE
least-cost
100
50
0
2000
2010
2020
2030
2040
2050
2060
2070
2080
2090
2100
argued that allowing more time for the transition would lower mitigation
costs. They did not attempt to quantify the savings from choosing one path
over another. Nor did they try to identify the least-cost mitigation pathway.
In the preceding sections, we analyzed the mitigation costs associated with the
WG1 and WRE pathways. We now turn to the question of what might
constitute a least-cost mitigation pathway for stabilizing concentrations at
550ppmv. For these calculations, we use MERGE 3.0. Rather than apply a
carbon constraint derived through inverse calculations with the Wigley
carbon cycle model, we now place a constraint on atmospheric concentrations
and use the model to identify the least-cost mitigation pathway.
Note from Figure 6.1 that the least-cost and WRE pathways for stabilizing
concentrations at 550ppmv lie fairly close together, at least in the early years.
That is, they tend to follow the emissions baseline during the first decade of
the next century and then depart gradually. Figure 6.2 shows the results in
terms of discounted present value. In each case, we assume trade among all
regions. As would be expected from the previous figure, the WRE and least-
cost cases are also close in terms of costs.
The cases differ dramatically, however, in terms of the value of carbon
emission rights. From Figure 6.3, we see that the least-cost path starts off at a
low price (approximately $2/ton of carbon) and rises gradually over time. The
WRE case leads to an erratic time path of carbon prices. Indeed, in some years
there is an excess of emission rights. As a result, their value falls to zero. In
other years, their value exceeds that of the least-cost optimal emissions
reduction path.
7. The costs of stabilizing concentrations at alternative levels
The selection of the 550ppmv target was purely arbitrary and not meant to
imply an optimal concentration level. Given the present lack of consensus on
what constitutes "dangerous" interference with the climate system, it is
important to understand how mitigation costs might vary with alternative
concentration targets.
Figure 7.1 summarizes the results of the MERGE analysis. As would be
expected, mitigation costs are a declining function of the stabilization target.
Recall that a concentration target places an upper limit on the amount of CO2
to be released into the atmosphere between now and the date at which the
target is to be achieved. This in effect defines an emissions budget. The lower
the target, the smaller the emissions budget.
Figure 7.2a shows the constraint on Annex 1 emissions during the initial
decades of the next century under the WG1 scenario. In the absence of
21
Figure 7.1 Mitigation Costs for Stabilizing Concentrations at Alternative Levels
-- discounted to 1990 at 5%
16
14
WG1 (w/o "where" flexibility)
WG1 ("where" flexibility)
12
WRE (w/o "where" flexibility)
10
Trillions of dollars
WRE ("where" flexibility)
8
6
4
2
0
450
550
650
750
ppmv
WRE (q
2030
2020
2010
20000
1990
0
1
450ppmv
Z
E
Billion tons of carbon
to
Awddoss
S
Awddoss
'8 1522
9
Ma (e
2030
2020
2010
20000
1990
0
1
450ppmv
550ppmv
N
Awddos9
E
Billion tons of carbon
X
to
*
*
*
S
1522
*
9
Alternative Concentration Targets
Figure 7.2 Annex 1 Emission Constraints under
"where" flexibility, this becomes an effective upper bound on emissions. The
figure provides useful insights into the shape of the abatement cost curve.
Relative to higher targets, 450ppmv implies that: 1) more carbon must be
removed from the energy system, 2) there is greater need to reconfigure the
existing energy using and energy producing capital stock, 3) low-cost
substitutes are likely to be available in a less timely manner, and 4) there is
less opportunity for discounting to reduce the present value of mitigation
costs. As the concentration constraint is relaxed, each of these factors acts to
lower costs.
The costs of complying with WG1 are substantially reduced when we allow
for "where" flexibility. Annex 1 countries are able to purchase lower marginal
cost abatement alternatives from non-Annex 1 countries. As a result, the
need is not as intense for early reductions.
WRE produces the lowest mitigation cost possibilities. The asymmetry in the
cost function between 450 and 550ppmv suggests that even with WRE, the
low target will provide insufficient time to adapt the existing capital stock.
From Figure 7.2b, note that a 450ppmv target would require a departure from
the baseline during the first decade of the next century, and there would be an
even more rapid departure thereafter. With targets of 550ppmv and above,
there is time for a more gradual transition away from carbon-intensive fuels.
8. The choice of near-term mitigation strategy
Figure 7.2b provides some useful guidance for the design of near-term
emission strategies. If it is certain that the target is 550ppmv or above, the
near-term emissions path appears to be quite robust. That is, it adheres fairly
closely to the emissions baseline through 2010. It should be noted, however,
that even in this case, there is some transition away from the world's current
heavy dependence on carbon-intensive technologies prior to 2010. That is,
inexpensive alternatives (e.g., renewables and cost-effective conservation) are
introduced in increasing amounts - both on the supply and demand sides of
the energy sector. However, if these alternatives are economically attractive
in their own right, they will be adopted in the absence of climate policy.
Suppose, on the other hand, that one believes there is some probability that
the target is in the 450 to 550ppmv range. A more aggressive departure from
the emissions baseline will be required. The degree of hedging depends upon
the probabilities and the relative costs of two types of errors in the design of
future capital stocks. That is, one must balance the risks of investing in capital
stocks that lead to carbon emissions that are either too high or too low.
Of course, the choice of emission pathway for meeting a prescribed
concentration target must also involve consideration of the environmental
24
consequences of adopting one emission trajectory over another. The WRE
emission pathways result in higher concentrations in the years preceding the
date by which the target is to be achieved. For the 550ppmv case, the higher
concentrations lead to pathway related differentials of up to .2 degrees C in
global mean temperature and 4cm in global mean sea level change (ref. 11).
To the extent that this leads to higher environmental damages, these need to
be balanced against the benefits from reduced mitigation cost.
9. Some concluding comments
The above analysis suggests that a more gradual transition away from fossil
fuels is likely to be less expensive in terms of mitigation costs. This should
not be interpreted as suggesting a "do nothing" or "wait and see" strategy.
Mitigation may mean action, but action does not necessarily mean mitigation.
As pointed out in the IPCC 1995 Report²⁰, climate policy requires a portfolio of
responses. The challenge facing today's policy makers is to arrive at a prudent
hedging strategy in the face of climate-related uncertainties. Among the
options are
immediate reductions of greenhouse gas emissions,
investments in actions to assist human and natural systems
adapt to climate change should it occur,
continued research to reduce uncertainties about how much
change will occur and what effects it will have, and
R&D on energy supply and end-use technologies to reduce the
costs of limiting greenhouse gas emissions.
The issue is not one of either-or but one of finding the right blend of options.
Policy makers must decide how to divide greenhouse insurance dollars
among these competing needs.
The present analysis has provided some useful insights bearing on this
decision. Deep near-term reductions are apt to be costly. They provide less
time to adapt the existing capital stock. There will be more opportunities for
reducing emissions cheaply as the current capital equipment turns over.
Indeed, the 1995 IPCC report states that "implementing emission reductions
at rates that can be absorbed in the course of normal capital stock turnover is
likely to be cheaper than forcing premature retirement now.
Fortunately, with regard to carbon dioxide, the issue is one of cumulative
rather than year-by-year emissions. This means that we can allow for an
economical turnover of the existing capital stock if we are prepared to make
sharper reductions in the future.
25
This brings us to the issue of R&D. Sharper reductions in the future will be
less problematic if we can lower the costs of fuel switching and conservation.
Indeed, studies by Stanford University's Energy Modeling Forum suggest that
the development of economically competitive alternatives to conventional
fossil fuels could substantially reduce the costs of a carbon constraint. 22
Although virtually all parties in the debate recognize the value of R&D, we
have yet to develop a technology strategy for dealing with global climate
change. How much should we be investing today to ensure ample supplies of
low-cost alternatives in the future? What should be the nature of these
investments, who would make them, and how would they be managed?
Given the size of the stakes, surprisingly little attention has been devoted to
these questions.
26
References
1
Intergovernmental Negotiating Committee for A Framework Convention on Climate Change
(1992). Fifth Session, Second Part, New York, 30 April-9 May.
2
United Nations Climate Change Bulletin, Issue 7, 2nd Quarter 1995, published by the interim
secretariat for the UN Climate Change, Convention, Geneva.
3 IPCC (1994). Climate Change 1994, Cambridge University Press.
4
Coase, R. (1960). "The Problem of Social Cost." Journal of Law and Economics, 3.
5
Intergovernmental Negotiating Committee for A Framework Convention on Climate Change
(1992), op. cit.
6
Manne, A., Mendelsohn, R. and Richels, R. (1995). "MERGE: A Model for Evaluating Regional
and Global Effects of GHG Reduction Policies." Energy Policy, 23 (1).
7 Manne, A. and Richels, R. (1995). "The Greenhouse Debate: Economic Efficiency, Burden
Sharing and Hedging Strategies." The Energy Journal, 16 (4).
8
Manne, A. and Schrattenholzer, L. (1996). "International Energy Workshop." International
Institute for Applied Systems Analysis, Laxenburg, Austria, January.
9 IPCC (1992). Climate Change 1992, Cambridge University Press.
10 IPCC (1994). Climate Change 1994, op. cit.
11 Wigley, T., Richels, R. and Edmonds, J. (1996). "Economic and Environmental Choices in the
Stabilization of Atmospheric CO2 Concentrations," Nature, Vol. 379, 18 January.
12 IPCC (1996). Climate Change 1995, Cambridge University Press.
13
Nordhaus, W. (1979). The Efficient Use of Energy Resources. Yale University Press, New
Haven.
14 Manne, A. and Richels, R. (1995), op. cit.
15 Richels, R. and Edmonds, J. (1995). "The Economics of Stabilizing Atmospheric CO2
Concentrations." Energy Policy, 23 (4/5).
16 Kosobud, R., Daly, T., South, D. and Quinn, K. (1994). "Tradable Cumulative CO2 Permits and
Global Warming Control," The Energy Journal, 15 (2).
17 IPCC (1996). Climate Change 1995.
18 Manne, A. and Richels, R. (1996). "The Berlin Mandate: The Cost of Meeting Post-2000
Targets and Timetables." Energy Policy, 24 (3).
19 Richels, R., Edmonds, J., Gruenspecht, H. and Wigley, T. (1996). "The Berlin Mandate: The
Design of Cost Effective Mitigation Strategies." EMF-14, Working Paper 3, Stanford
University, Stanford, CA.
20 IPCC (1996). Climate Change 1995, op. cit.
21 IPCC (1996). Climate Change 1995, op. cit.
22
Energy Modeling Forum (1993). "Reducing Global Carbon Emissions: Costs and Policy
Options." EMF-12, Stanford University, Stanford, CA.
27
A Regional Dynamic General-Equilibrium Model
of Alternative Climate-Change Strategies
pp.
:change
ge Rate
By WILLIAM D. NORDHAUS AND ZILI YANG*
versity,
Most analyses treat global warming as a single-agent problem. The present study
change
presents the Regional Integrated model of Climate and the Economy (RICE)
of Eco-
model. By disaggregating into countries, the model analyzes different national
9-82.
strategies in climate-change policy: pure market solutions, efficient cooperative
lerlind,
outcomes, and noncooperative equilibria. This study finds that cooperative pol-
wedish
icies show much higher levels of emissions reductions than do noncooperative
urnal,
strategies; that there are substantial differences in the levels of controls in both
)-79.
the cooperative and the noncooperative policies among different countries; and
Esti-
that high-income countries may be the major losers from cooperation. (JEL H41,
e Eu-
Q4, Q2, Q20)
se of
tional
atility,
Although the issue of greenhouse warming
checked, recent surveys indicate that over the
bility:
was first seriously studied a century ago, it
next century the globally averaged surface tem-
ity."
has over the last decade emerged as the central
perature will rise around 3°C (degrees Celsius),
earch
international environmental question. Most na-
which would produce climates that are unprec-
No.
tions have adopted the Framework Convention
edented during the entire span of human civili-
on Climate Change negotiated at the 1992 Rio
zation. While warming may seem benign, it has
E. O.
Earth Summit. Under the Convention, nations
major and unpredictable impacts on weather
th-
agreed to take steps to limit carbon dioxide
patterns, ocean currents, sea-level rise, river run-
J:
(CO₂) and other greenhouse gas (GHG) emis-
offs, storm and monsoonal tracks, desertifica-
sions before they reach "dangerous" levels.
tion, and other geophysical phenomena. Many
lign-
Having increased its CO₂ emissions at an av-
scientists and ecologists view these changes and
uring
erage growth rate of almost 2 percent annually
uncertainties with alarm.
vian
for about a century, the United States has com-
The other half of the calculus is the cost of
(2),
mitted itself to capping its emissions at 1990
slowing climate change. Even the most dra-
levels, and many other high-income countries
conian policies (such as a virtual phaseout of
Tar-
have made similar or even more ambitious
fossil fuels) would only slow and not stop cli-
ers,
proposals (for a review of commitments, see
mate change, and significant steps to slow the
Daniel M. Bodansky [1995] or International
rate of increase of climate change would cost
Re-
Energy Agency (IEA) [1994]).
hundreds of billions of dollars annually using
es."
The climate-change issue is so controversial
today's energy technologies. Given the many
Fall
primarily because the stakes are so high. If un-
economic issues facing humanity, it would re-
quire an unusually dire risk and uncommonly
lity:
statesmanlike behavior for nations to divert 1
cta-
* Nordhaus: Department of Economics, Yale Univer-
or 2 percent of their national incomes today to
sity, 28 Hillhouse Ave., New Haven, CT 06511; Yang:
ean
reduce conjectural risks that will not occur un-
Center for Energy and Environmental Policy Research,
pp.
MIT, Cambridge, MA 02137. This research was supported
til well into the next millennium.
by the National Science Foundation and the U.S. Environ-
In addition to the grave risks and huge costs,
mental Protection Agency. This research has benefited
the issue of greenhouse warming is difficult
from discussions and comments of Richard Eckaus,
because the problem is so complex. It involves
William Hogan, Alan Manne, Richard Richels, Herbert
Scarf, and two referees. All views and errors of omission
a series of poorly understood systems, includ-
or commission are the sole responsibility of the authors.
ing the carbon cycle, climate reactions, geo-
Correspondence can be directed to W.D. Nordhaus.
physical, ecological, and biological impacts of
741
742
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
climate changes, economic impacts, along
I. Description of the RICE Model
with potential adaptations and new technolo-
gies, with all of these stretching over a period
A. Overview
of a century or more. Social and natural sci-
entists have made impressive advances in un-
This section begins with a succinct descrip-
derstanding each of these systems over the last
tion of the RICE model; the equations of the
quarter century, and numerous efforts are un-
model are provided in Appendix A.² The RICE
derway today to link together the different
model, or Regional Integrated model of Cli-
components into an integrated assessment of
mate and the Economy, is a regional, dynamic,
climate change policies. One of the earliest in-
general-equilibrium model of the economy
tegrated models was the DICE model, which
which integrates economic activity with
is a globally aggregated model integrating a
the sources, emissions, and consequences of
general-equilibrium model of the global econ-
greenhouse-gas emissions and climate change.
omy with a climate system including emissions,
Most existing models of global climate change
concentrations, climate change, impacts, and
take the vantage point of the Global Com-
optimal policy (see Nordhaus, 1992, 1994).
moner engaged in determining how nations
Other recent integrated models of climate
should design sensible strategies to cope with
change include Alan S. Manne and Richard
future climate change. The RICE model takes
Richels (1992), Stephen C. Peck and Thomas
a positive point of view by asking how nations
J. Teisberg (1992), and Zili Yang (1993).
would in practice choose climate-change pol-
Globally aggregated models have the short-
icies in light of economic trade-offs and na-
coming of losing many of the interesting and
tional self-interests. Put differently, global
C
important details of different regions. Perhaps
optimization models ask how nations would
the central shortcoming, however, is that
choose the optimal (or Pareto-efficient) path
global models ignore the fact that policy de-
for reductions of GHGs. The RICE model
S
cisions to reduce GHG emissions are taken
allows us to calculate not only the efficient
primarily at the national level. It is single
path (which we designate the cooperative ap-
c
nations, not the United Nations, that determine
proach) but also to compare that path with
e
energy and environmental policy, so any grand
noncooperative approaches.
t
design to slow global warming must be trans-
In the RICE model, the world is divided
C
lated into national measures. The purpose of
into a number of regions. Each is endowed
S
the present study is to improve the realism of
with an initial capital stock, population, and
r.
integrated assessments by lodging policy mak-
technology. Population and technology grow
o
ing at the more appropriate national level. This
exogenously, while capital accumulation is de-
involves introducing a number of regions of
termined by optimizing the flow of consump-
the world and considering different degrees of
tion over time. Output is produced by a
cooperation among nations.
Cobb-Douglas production function in capital,
The present paper reports on the results of
p
labor, and technology. In the long run, capital
c
the current version of the RICE model.¹ It out-
is fully mobile so that the real return on capital
lines briefly the philosophy, sketches the mod-
eling structure, and describes the major results.
b
2 The structural equations of the RICE model are gen-
erally the same as those of the aggregated DICE model.
1 An experimental version of the RICE model with il-
For a detailed discussion of the derivation of the equations,
lustrative data was presented at the MIT Conference on
see Nordhaus (1994). The GAMS program for the RICE
pl
the Environment (see Nordhaus, 1990). The current ver-
model is available from the authors upon request.
(l
sion (called RICE-6.3.2 for purposes of documentation)
3 This study identifies the cooperative solution as the
sl
incorporates a number of changes, primarily a revision of
one that generates an efficient level and distribution of
the treatment of non-CO₂ greenhouse gases and improved
er
emissions. The solutions that might emerge from in-
estimates of the economic and emissions data. A major
ternational negotiations are a further issue that is not
R
cause of the long gestation period of this research has been
addressed in this study. Issues concerning possible bar-
of
the difficulty in finding a satisfactory algorithm for solving
gaining outcomes are discussed below in Section II.C.
er
the intertemporal general equilibrium (see below).
"Welfare Effects by Region."
to
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
743
is equalized across regions. The preference
Market policies. The market approach is
function of each region is a utility function
one in which there are no controls on the
which is the sum of discounted utilities of per
emissions of greenhouse gases. This has
capita consumption times population, where
been the approach followed by virtually all
:cinct descrip-
the pure rate of social time preference (the dis-
nations up to now.
uations of the
count rate on utility) is 3 percent per year in
Cooperative policies. The second approach
A.² The RICE
each region. The utility function is logarithmic
is the ideal one in which global environ-
model of Cli-
in per capita consumption.
mental concerns are treated cooperatively
mal, dynamic,
The major contribution of the integrated ap-
through the efficient actions of all nations.
the economy
proaches like the RICE model is to integrate
In this approach, nations agree to reduce
activity with
the climate-related sectors with the economic
CO₂ emissions in a globally efficient way.
sequences of
model. This part of the model contains a num-
This solution is efficient but requires an un-
mate change.
ber of geophysical relationships that link to-
realistically high degree of cooperation.
imate change
gether the different forces affecting climate
Noncooperative policies. In the third ap-
Global Com-
change, generate the greenhouse-gas emis-
proach, individual nations undertake poli-
how nations
sions, and measure the impacts of climate
cies that are in their national self-interests
to cope with
change. RICE includes region-specific emis-
and ignore the spillovers of their actions on
model takes
sions equations, a global concentrations equa-
other nations. In the noncooperative ap-
! how nations
tion, a global climate-change equation, and
proach, to the extent that nations are small
:-change pol-
regional climate-damage relationships. En-
and the externality is truly global, efforts to
offs and na-
dogenous emissions are limited to CO2, while
reduce CO₂ emissions will be much smaller
ently, global
other greenhouse gases are treated as exoge-
than in the global cooperative solution. This
ations would
nous. Uncontrolled emissions are a slowly
solution is inefficient but realistic.
ficient) path
declining fraction of gross output-a relation-
RICE model
ship which is consistent with the observed
B. Basic Structure
the efficient
"decarbonization" in most countries over this
ope
? ap-
century that is also predicted by more detailed
We outline here the major features and in-
at
with
energy models. CO₂ emissions can be con-
novations of the RICE model; the equations of
trolled by increasing the prices of factors or
the model are contained in Appendix A.
d is divided
outputs that are CO₂ intensive, and we repre-
The RICE model divides the global econ-
is endowed
sent the CO₂-reduction cost schedule paramet-
omy into 10 different regions. The first five are
ulation, and
rically by drawing upon a number of studies
1) the United States, 2) Japan, 3) China, 4)
hology grow
of the cost of CO₂ reductions. Climate change
the European Union, 5) and the former Soviet
nation is de-
is represented by the realized global mean sur-
Union (FSU). Each is treated as a single de-
of consump-
face temperature, which uses relations based
cision maker. The last five regions have dif-
uced by a
on current climate models. The economic im-
ferent numbers of countries, and each is
n in capital,
pacts of climate change are assumed to be in-
treated as multiple decision makers. These five
run, capital
creasing along with the realized temperature
regions are 6) India, 7) Brazil and Indonesia,
rn on capital
increase. The impacts of climate change are
8) 11 large countries, 9) 38 medium-sized
estimated from a number of different studies,
countries, and 10) 137 small countries. (Basic
but it must be recognized that this is the most
data on the major regions are contained in Ap-
uncertain part of the model.
pendix B.) To reduce the severe computational
model are gen-
The major economic choices faced by
complexity of the solution, we sometimes ag-
I DICE model.
nations (or the concert of nations) in this ap-
gregate regions 6 through 10 into one region
I the equations,
1 for the RICE
proach are (a) to consume goods and services,
as the "rest of the world" or "ROW."
equest.
(b) to invest in productive capital, and (c) to
The goal in creating the different regions is
solution as the
slow climate change through reducing CO₂
to structure the problem so that the noncoop-
distribution of
emissions. The new element introduced in the
erative equilibrium is equivalent to the full but
erge from in-
RICE model and not present in other models
enormous game with about 200 countries. This
ue that is not
possible bar-
of global warming is the possibility of differ-
is done by allocating the smaller countries to
Section II.C,
ent strategies undertaken by nations. We dis-
groups so that within each group the national
tinguish three distinct approaches:
benefits from slowing climate change are
744
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VOL. 86 NO. 4
roughly equal. We then mimic the free-riding
TABLE 1-FUTURE LEVELS OF INCOMES,
emissions. 1
temptations of global public goods by dividing
DIFFERENT REGIONS
United State
the benefit function for each region by the
number of countries (that is, decision-making
Ratio of region's per capita
other regions
units) within that region.
income to that of the
have parame
United States (US₁₉₉₀ = 1)
functional fo
An example will clarify the way regions are
used. Region 9 contains 38 countries-includ-
Region
1990
2100
2200
estimated the
on the basis
ing Bulgaria and Hungary, which are countries
1) United States
1.00
3.11
4.69
with roughly similar populations and econo-
2) Japan
1.09
4.07
4.83
undertaken b
mies. We assume that all the countries in re-
3) China
0.02
0.47
1.55
eling Forum
4) European Union
0.85
2.89
4.27
Estimates (
gion 9 are similar in terms of their sizes,
5) Former Soviet Union
0.14
0.87
2.02
mitigation cost functions, and damage func-
ages from cl
6) Rest of the world
0.07
0.84
1.69
tions. Hence, for region 9 the (slightly simpli-
stage. There
fied) net benefit function to be maximized in
Note: These values are the values of per capita GDP gen-
mated impact
erated by the market solution for the RICE model. The
keted sectors
the noncooperative case is N(E₉) = B(E₉)/38
GDPs are calculated using market exchange rates.
reliable studi
C(E₉), where N(E₉) is the net benefits of
emissions for region 9, E₉ is emissions in re-
for developin
gion 9, B(E₉) is the benefit of emissions, 38
pacts in diffe
is the number of equal-sized decision makers
damage funct
tivity differences should largely disappear
tical for each
in region 9, and C(E₉) is the cost function.
over the long run.
and that the c
Therefore, when the representative country in
The assumed ratios of long-run levels of per
rameters as 1
region 9 maximizes its net economic welfare
capita GDPs to that of the United States are
in the noncooperative case, not only will it ig-
States. Impac
given in Table 1, showing the observed values
nore the benefits accruing outside region 9, but
culated by tal
for 1990 along with projections for 2100 and
ferent sectors
it will also internalize only 1/38 of the benefits
2200. While highly conjectural, these esti-
of the region. This procedure includes in a
and so on) in
mates are consistent with recent trends in
computationally feasible manner all the dif-
gregating tho
country GDP growth. One interesting feature
ferent countries while ensuring that the incen-
estimates. (T
of this approach is that it gives considerably
tives for free-riding are maintained.
Nordhaus [19
higher estimates of output and emissions than
A major difficulty in constructing the RICE
gate do not (
do the conventional global models, such as
model has been to estimate the regional pa-
major estima
those used by governments in the Intergovern-
rameters of the different functions.⁴ Gross do-
Fankhauser [
mental Panel on Climate Change (IPCC). For
mestic products, populations, CO₂ emissions,
in Nordhaus I
the modeling, each region's income growth is
sized that the
and capital stocks are taken from a variety of
generated through Hicks-neutral technological
international sources. Future population growth
across countr
change, which starts at approximately the ob-
estimates are taken from the United Nations
jectural. Tabl
served rates for 1960-1990. After 1990,
projections. The major uncertainty in the eco-
sumptions foi
growth rates are assumed to decline exponen-
nomic projections is long-run levels of per
tially in a manner leading to the asymptotic
capita output in the different regions. These
productivity ratios shown in Table 1.
projections are based on the assumption of
CO₂ emissions are separated into industrial
partial convergence of per capita incomes.
emissions (largely from fossil fuels) and those
5 See Andrew
That is, we assume that the relative differences
from land-use changes and are calibrated to
Darius W. Gaskin
in regions' per capita incomes decline over
1990 levels. The ratio of CO₂ emissions to out-
tional form of the
time but do not disappear. The extent of con-
model was estima
put is assumed initially to decline at different
duction in nine fa:
vergence is a controversial issue, but to the
rates, with each region's decline rate decreas-
United States and
extent that differences in per capita incomes
ing along with the overall rate of technological
where i is region i
are primarily based on differences in the extent
change by region. Here again, asymptotic
sions, b₁., and b₂
of adoption of available technologies, produc-
control rate or fra-
CO2-output ratios are assumed to converge
market path, Y,(t)
considerably but not completely in the future.
1 is the time peri
The costs of reducing emissions by region
exponents (b₂) are
4 A detailed list of sources and data are available from
are estimated separately on the basis of the ex-
the intercepts (b₁.,
the authors.
the different cou
isting studies of the cost of reduction of CO₂
above.
ER 1996
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
745
emissions. Most studies are based on the
The climate-change policies are character-
United States and Europe, and estimates for
ized by "control rates" and "carbon taxes."
other regions have low levels of reliability. We
Control rates are simply the percentage reduc-
er capita
have parametrized the cost function using the
tions in CO₂ emissions relative to a baseline
of the
1990 = 1)
functional form from earlier studies but have
or uncontrolled path. Carbon taxes represent
2200
estimated the intercepts of the cost functions
the marginal cost of reducing CO₂ emissions.
on the basis of the international comparisons
A carbon tax would equal the price of a
4.69
undertaken by the OECD and by Energy Mod-
carbon-emissions permit if there were tradable
4.83
1.55
eling Forum 13.⁵
permits, and the prices of such permits in dif-
4.27
Estimates of the economic impacts or dam-
ferent countries would obviously be equalized
2.02
ages from climate change are sparse at this
(at market exchange rates) if permits were
1.69
stage. There are numerous studies of the esti-
freely tradable. In the market solution, carbon
GDP gen-
mated impact of climate change on the mar-
taxes are zero. In the cooperative solution,
keted sectors for the United States, but few
emissions are curtailed in a cost-effective
odel. The
S.
reliable studies for the nonmarket sectors or
manner. The model does not deal explicitly
for developing countries. To estimate the im-
with mechanisms by which winners might
pacts in different regions, we assume that the
compensate losers, although we discuss some
damage function from climate change is iden-
of the issues below.
sappear
tical for each industry across different regions,
and that the cost functions have the same pa-
C. Algorithm to Calculate
is of per
rameters as those estimated for the United
General Equilibrium
ates are
States. Impacts in different regions are cal-
1 values
culated by taking the estimated shares of dif-
The RICE model presents a radically differ-
100 and
ferent sectors (agriculture, coastal activities,
ent philosophy for estimating strategies to
se esti-
and so on) in national output and then ag-
cope with global warming from global-
ends in
gregating those up to obtain overall national
optimization models used in many integrated
feature
estimates. (This approach is described in
assessments. The baseline calculation is cali-
ider21
Nordhaus [1994].) The results in the aggre-
brated to a market equilibrium of the world
ons
gate do not differ markedly from the other
economy with all the differences in popula-
suc.
major estimates (see particularly Samuel
tions, technologies, and incomes-the world
govern-
Fankhauser [1993] and the survey of experts
is taken as it is for the purpose of the baseline
'C). For
in Nordhaus [1994]), but it must be empha-
calibration. We then calculate different strat-
rowth is
sized that the distribution of climate impacts
egies for global warming conditional on the
ological
across countries is at this stage highly con-
existing distribution of capital, labor, and tech-
the ob-
jectural. Table 2 shows the major inputs as-
nology. The strategies include doing nothing
r 1990,
sumptions for the different regions.
(the market solution), finding an efficient
xponen-
solution given the existing distribution of in-
vmptotic
come (the cooperative solution), and finding
the solution in which nations select policies to
ndustrial
maximize national preferences alone (the non-
nd those
5 See Andrew Dean and Peter Hoeller (1992) and
Darius W. Gaskins and John P. Weyant (1993). The func-
cooperative or nationalistic equilibrium). This
rated to
tional form of the mitigation-cost function in the DICE
public-choice approach is in sharp contrast to
is to out-
model was estimated from studies of the cost of CO₂ re-
many of the debates on climate change today;
different
duction in nine families of models primarily based on the
in these, the distributional issues of who shall
decreas-
United States and takes the form C,(t) = b₁.ᵢµ,(t)b₂Y₁(t),
pay to slow climate change rise to the top of
hological
where i is region i, Cᵢ(t) = the cost of reducing CO₂ emis-
sions, b₁, and b₂ are parameters, µᵢ(t) is the emission-
the agenda.
ymptotic
control rate or fractional reduction in emissions from the
We now describe the algorithm for finding
converge
market path, Y,(t) is region i's gross regional product, and
the cooperative solution in the RICE model.
e future.
1 is the time period. The RICE model assumes that the
The technique we employ originates with
y region
exponents (b₂) are the same across countries and calibrates
T. Negishi (1960), was discussed briefly in
the intercepts (b₁.ᵢ) to estimates of the cost functions from
of the ex-
the different countries or regional models mentioned
Nordhaus (1990) in the context of global
1 of CO₂
above.
warming, and has been used in similar models
746
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VOL. 86 NO.
TABLE 2-MAJOR INPUT PARAMETERS FOR THE RICE MODEL
an arbitrar
would gen
Climate
CO₂ emissions, 1990
Per capita
which imp)
Cost
damage
Population
output
CO₂ ratio,
live within
Region
intercept"
interceptb
Land-useᶜ
Industrialᵈ
2100°
(2100)'
2100'
variables ai
United States
0.07
0.01102
0.010
1.360
0.294
68.8
0.1190
welfare-we
Japan
0.05
0.01174
0.000
0.292
0.125
89.1
0.0630
are equal :
China
0.15
0.01523
0.136
0.669
1.656
9.9
0.5120
European Union
0.05
0.01174
0.100
0.872
0.427
63.0
0.0740
straints is 1
Former Soviet Union
0.15
0.00857
0.000
1.066
0.366
18.9
0.3220
Hence, t
Rest of world
0.10
0.02093
1.730
1.700
6.738
18.1
1.1850
the welfare
variables 4
a The intercept of cost function equals the fraction of annual output required to reduce net CO₂ emissions to 0.
of consum
b The intercept of climate-damage function equals the reduction in annual net output from an increase of 2.5°C in
global mean temperature.
c Emissions are measured in billions of tons carbon per year. Land-use emissions are primarily from deforestation.
(3)
φ'(7
d Emissions are measured in billions of tons carbon per year. Industrial uses primarily from burning fossil fuels.
e Population is in billions of people.
1 Gross domestic product (GDP) is measured at 1990 market exchange rates in thousands of 1990 U.S. dollars.
& The ratio is of industrial CO₂ emissions to GDP (tons of carbon per $1000 of output in 1990 U.S. dollars).
Combinin:
each of the
isfied and
by Manne and Thomas Rutherford (see, par-
optimizing a global social welfare function of
change in
ticularly, 1994). The theoretical basis for the
the form:
the Negisl
algorithm is a theorem of Negishi which relies
timized 01
on the second theorem of welfare economics.
N
generated
Negishi suggested and proved that under cer-
(1) W = Σ c¹(2),
equi-librit
i=1
tain conditions a competitive equilibrium can
dowments
be found by maximizing a social welfare func-
c'(t),
c'(T)]
equilibriu
tion of N agents in which the welfare weight
solution.'
of each of the agents is adjusted to satisfy the
where W is the value of the global social wel-
Unsatis
agent's budget constraint. We will call this
fare function and Φ¹ are the welfare or Negishi
to the fo
equilibrium the Negishi solution.
weights for country i, i = 1, N. The U' are
Negishi S(
What are the appropriate welfare weights?
the preference functions for the different coun-
pure Negi
In our calibration, we adopt the realistic ap-
tries, and the c'(t) are the consumption bun-
tremely 1.
proach by taking the welfare weights that re-
dles of the countries.
(this is a
flect the actual economic outcome across
The relevant excess demand is found in the
optimized
regions. We do this not as a brief for the ex-
intertemporal budget constraint of each region.
realistic,
isting international distribution of resources
To find the competitive equilibrium, we add a
to impose
and income but because it is the starting point
constraint to the problem that requires each re-
on debt ai
for analyzing potential improvements in eco-
gion to satisfy its intertemporal budget con-
foreign in
nomic welfare that would arise from policies
straint, which is represented by terminal net
limits. TI
that are imposed on the actual world economy.
foreign assets, NFA'(T), T being the last
GDP ratio
Hence, the weights are ones such that the ex-
period:
assets to (
cess demands in all markets are zero at the
account C
given welfare weights and prices.⁶ More pre-
(2)
NFA'(T) = 0,
i = 1, .. , N.
pendix A
cisely, the algorithmic procedure is the follow-
based on
ing. We first solve the RICE model by
Next, define φ'(T) as the dual variable of
which in economic terms is the
marginal utility of consumption or income in
the last period. Given condition (2), φ'(T) is
7 The dit
a function of the welfare weights and we can
6 A brief but illuminating discussion of the Negishi ap-
flows is not
proach is in contained in Andreu Mas-Colell et al. (1995
write these functions as φ'(T) = G'(Φ¹, Φ²,
the same is
pp. 630-31).
Φ),
i
Il
1,
N. Without condition (2),
employed.
!BER 1996
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
747
an arbitrary set of social welfare weights
virtually no difference for the results of the
would generate a set of nonzero NFA'(T),
analysis below.
which implies that at least one region does not
Given these constraints on international
CO₂ ratio,
live within its budget. However, when the dual
2100
capital flows, our algorithm will not produce
variables are equalized across all countries, the
the necessary complete price equalization for
0.1190
welfare-weighted marginal utilities of income
carbon-trading permits, which are assumed to
0.0630
0.5120
are equal and the intertemporal budget con-
be fully tradable and reach price. To ensure
0.0740
straints is therefore satisfied.
price equalization for carbon-emission rights,
0.3220
Hence, the algorithm works by searching for
we adjust. the Negishi weights across regions
1.1850
the welfare weights, as a function of the dual
for every period. We call this new algorithm
variables φᵢ(T), so that the marginal utilities
to 0.
the time-dependent Negishi solution. It differs
of 2.5°C in
of consumption are equalized:
from the pure Negishi solution because it in-
corporates the constraints on capital flows so
restation.
(3) = Φ) =
that the regional budget constraints are binding
1 fuels.
for every period. As a result, carbon-emissions
llars.
for all i = 1, N.
permits have equal prices in all regions in each
s).
time period (at market exchange rates). Under
Combining (1), (2), and (3), we know that
this revised algorithm, we seek the time-
each of the country budget constraints is sat-
dependent Negishi weights, Φ'(t). To find
isfied and that no region can gain from a.
these, we first solve the model with an arbi-
inction of
change in the resulting allocation. Hence, by
trary set of welfare weights while continuing
the Negishi theorem, we know that this op-
to impose (2). Following the Negishi theorem,
timized outcome using the welfare weights
we then reset the welfare weights for all coun-
generated in (3) represents a competitive
tries and time periods according to the follow-
equi-librium consistent with the initial en-
ing formula:
dowments, technology, and preferences. The
equilibrium thus found is the "pure Negishi
1
solution."
sci
Unsatisfactory aspects of the solution led
(4)
or
to the following refinements of the pure
"he Ui are
Negishi solution. The major problem with the
φ'(t)
rent coun-
pure Negishi solution was that it generated ex-
tion bun-
tremely large capital flows among regions
This equation sets the welfare weights equal
(this is a common feature in intertemporally
to the inverse of the marginal utilities of con-
und in the
optimized models).⁷ Because these are un-
sumption. The search algorithm based on (4)
ch region.
realistic, we took one further step which was
very quickly converges to a solution that sat-
we add a
to impose certain flow and stock constraints
isfies (2) and (3). We have conducted a
es each re-
on debt and current accounts to ensure that net
number of experiments and have found no in-
dget con-
foreign investment does not exceed certain
dication of multiple equilibria.
minal net
limits. These limitations limited the export-
What is the underlying economic rationale
; the last
GDP ratio to 1, limited the ratio of net foreign
for this algorithm? The solution represents a
assets to output to 0.1, and limited the current
competitive equilibrium under the assumption
account deficit to GDP ratio to 0.1 (see Ap-
that the preferences or technological con-
N.
pendix A for details). These constraints were
straints limit the international flows of capital.
based on observed limitations, but they made
For example, there may be strong home-
ariable of
country preferences in portfolios because of
ms is the
limitations of the marketability of human cap-
income in
ital. The limitation of this approach is that
φ'(T) is
7 The difficulty raised by unrealistically high capital
to the extent that the constraints on capital
nd we can
flows is not related to the use of the Negishi technique;
flows have nonmarket-clearing elements due
(Φ¹, Φ²,
the same issue would occur if fixed-point methods were
to rationing, the excess demands will not be
dition (2),
employed.
zero and we may depart from the market
748
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VC
equilibrium (which would in any case be dif-
regions by optimizing for each region holding
T
ficult to compute).
the control rates and resulting emissions, con-
Once we have obtained a competitive equi-
centrations, and impacts in other regions from
librium, we then perturb various elements,
the previous iteration fixed. We continue to
1.
such as the climate parameters or the cost
cycle through this sequence until the set of
functions, and resolve the maximization in
control rates are unchanged given the set of
(1). We do this holding the welfare weights
noncooperative strategies of other countries,
2.
constant across runs. This resolves the index
which is then the Nash equilibrium. The out-
number problem of changing prices by calcu-
come matches well the theoretical predictions
lating the welfare changes at the market wel-
and is in our simulations invariant to initial
fare weights.⁸
conditions, which suggests that the Nash equi-
librium is unique.
3.
D. Finding the Noncooperative Equilibrium
How reasonable is this solution concept?
While the pure Nash equilibrium is a sensi-
The algorithm just described provides the
ble assumption for small countries like Chad,
solutions for both the market and the cooper-
whose global warming policies will hardly
ative equilibrium. A different approach is nec-
make the front pages, it may lack realism for
essary to find the noncooperative equilibrium.
large or influential countries. Large coun-
The noncooperative or nationalistic equilib-
tries like China and influential countries like
rium exists as the equilibrium of the strategies
the United States would probably want to
of the different countries. We hence need an
take into account the effect of their policies
assumption about strategies and a method of
on other countries' policies. The ambivalent
finding the equilibrium.
policy on global warming by the United
str:
As for strategies, we assume that each na-
States over the last decade has undoubtedly
eff
tion determines its policies by maximizing its
strengthened the hand of those in other coun-
wit
domestic intertemporal utility function assum-
tries who want to do little. An alternative
app
ing that other nations' strategies are unaffected
approach would be for countries to posit
glc
by its policies. The noncooperative strategies
conjectural variations or reactions of other
har
are hence dynamic, full-information, Nash
countries to their policies. For example, the
stri
strategies, and we are seeking the Nash equi-
United States might assume that Japan or Eu-
be
librium. Technically, our solution is a Nash
rope would be a follower in terms of carbon-
mc
equilibrium in a finite game with perfect in-
tax policies or tradable emissions policies.
RI
formation, and it is therefore time consistent.
Another possibility would be to model coa-
fid
Such games have pure strategy Nash equilibria
litions of different countries. We have not
col
which can be calculated through backward in-
explored these alternative solution strategies
jor
duction, which is essentially what our algo-
in the present paper. Once we admit nonzero
lon
rithm does (for a discussion, see Mas-Colell
conjectural variations, we are in a deep
dai
et al. [1995 Chapter 9]).
thicket and the possibilities become unlim-
More precisely, we assume that each nation
ited. Future research will examine the pos-
A.
sets its own control rate over time [µ' =
sibility of coalitions of countries.
{µ'(1), µ'(2), µ'(3), µ'(t), µ'(T)};
i = 1, , N] so as to maximize its national
E. The Economic and Environmental Impact
and
objective function taking the control rates of
of Alternative Strategies
Fig
the other regions {µ¹, , µⁱ⁺
of 1
µⁿ} as given. Beginning with an initial set of
Using the algorithms just described, we will
sta
control rates, we iterate through the different
analyze the three different strategies as de-
em
scribed in Table 3: market, cooperative, and
do
noncooperative. In addition, for reference we
as
sometimes compare the results of the RICE
8The RICE model runs on the GAMS software (see
Anthony Brooke et al., 1988). The full model including
model to those of its parent, the DICE model,
searching for welfare weights takes approximately 6 hours
which is essentially a one-region efficient or
9
on a 486-66 processor.
cooperative solution.
in t
ER
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
749
holding
TABLE 3-ALTERNATIVE SOLUTION CONCEPTS FOR THE
regional outputs are shown in Figure 1; these
IS, con-
RICE MODEL
indicate that the projected relative sizes of
as from
the Chinese and ROW economies grow
inue to
1. Market RICE: This strategy assumes that there
set of
is no correction for the climate-change
sharply over the next century. The output
externality and that there is therefore no
growth in the RICE model is significantly
set of
abatement of CO2 emissions.
larger than that in many projections prepared
untries,
2. Cooperative RICE: In this strategy, countries
by international study groups, most of which
ne out-
undertake policies that reduce greenhouse-gas
envision a stability of current relative in-
lictions
emissions efficiently. The reduction of CO₂
come differentials rather than the projected
initial
emissions is efficient across countries and
partial convergence in the RICE model. Note
h equi-
across time.
as well that we use market exchange rates
3. Noncooperative RICE: This strategic concept
because we will want to find the equilibrium
ncept?
assumes that each country sets its CO₂
in which the prices of internationally-traded
sensi-
emissions controls to maximize its own
Chad,
economic welfare assuming that other
carbon-emissions permits are equalized.
countries' control strategies are invariant to a
Emissions are also considerably higher in
hardly
country's policies.
RICE than in the many other projections. For
sm for
example, CO₂ emissions in the RICE model
coun-
reach 38 billion tons of carbon by the year
es like
2100 in the market or uncontrolled run. This
ant to
II. Results
compares with an estimated 21 billion tons in
olicies
the DICE model and a range of 5 to 35 billion
valent
We now report the results of the policies and
tons in the IPCC projections (see T. M. L.
United
strategies described above. As in all modeling
Wigley [1994] for a description). CO₂ emis-
btedly
efforts of this kind, they should be interpreted
sions grow substantially faster in the RICE
coun-
with caution as this study is the first empirical
model partially because of the projected rapid
native
application of noncooperative game theory to
growth in output and partially because of the
T
global environmental policy. On the other
rising output share of regions with high
o
hand, the major results concerning the level of
emission-output ratios.
ie, the
stringency of climate-change policies have
Figure 2 shows the resulting CO2 emissions
or Eu-
been relatively stable over a wide variety of
under the different solution concepts and also
arbon-
models and alternative specifications of the
compares estimates from this study with the
licies.
RICE model, so we have considerable con-
earlier DICE model. Model estimates (not
el coa-
fidence in these estimates (conditional, of
shown) indicate that the share of CO₂ emis-
ve not
course, on the assumptions underlying the ma-
sions will rise sharply in China, region S1
itegies
jor components, such as those concerning the
(India), region S3 (middle-sized developing
onzero
long-run growth projections, the costs and
countries like Thailand), and region S4 (smaller
deep
damages, and the discount rate).
developing countries). These four regions ac-
unlim-
counted for about one third of CO2 emissions
e pos-
A. Output, Emissions, and Climate Change
in 1990 but are projected in the market runs of
the RICE model to comprise three quarters of
The projections for the major economic
emissions by 2100.
mpact
and environmental variables are shown as
CO₂ concentrations are shown in Figure 3.
Figures 1 through 4. One important outcome
Given the higher emissions rates in the RICE
of this study is that the RICE model has sub-
model, its concentrations rise more rapidly than
ve will
stantially higher projected world output and
in the DICE model. It is useful to examine the
as de-
emissions by the end of the next century than
date of doubling of CO₂ concentrations relative
and
do many other integrated assessments, such
ce we
as the earlier DICE model.⁹ Projections for
RICE
nodel,
emmental Panel on Climate Change (IPCC) (1990), the re-
sults in Nordhaus (1994), and preliminary results of the sur-
ent or
This statement is based on a comparison of the results
vey of models by the Energy Modeling Forum 14 directed
in the RICE model with the projections of the Intergov-
by John Weyant, Energy Modeling Forum (EMF) (1995).
750
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VOL. 86 N(
100.0
40
Rest of World
35
Europe
30
Output (trillons of 1990 U.S. dollars)
*
Billion tons of carbon per year
25 -
10.0
USA
X
20
FSU
China
15
Japan
10
1.0
1990
2010
2030
2050
2070
2090
5
FIGURE 1. REGIONAL OUTPUTS: COOPERATIVE SCENARIO
to preindustrial concentrations; that benchmark
strategies reduce warming by considerably less
is taken to be 1,200 billion tons of atmospheric
(a reduction of 0.086°C in 2100), both com-
son for
CO₂ concentrations (or 565 parts per million of
pared to the market strategy. One reason that
between
CO₂). The doubling date is 2100 in the (coop-
the difference in the temperature increase be-
that the i
erative) DICE model, 2070 in the cooperative
tween the cooperative and the market runs is so
economic
RICE model, and 2065 in both the market and
small is because of the long time lag between
small red
the noncooperative model. The doubling time
changes in emissions and temperature increases
for the CO₂ equivalent of all greenhouse gases
(the difference between the runs grows over
is slightly earlier than those for CO₂ alone.
time as the lags in the emissions-concentrations-
The projected increase in global mean tem-
temperature relationship plays out). 11 Addi-
We ne
perature over the 1990-2100 period is shown
tionally, the difference is small because of the
the diffe
in Figure 4.¹⁰ The estimated temperature in-
nonlinear relationship between CO₂ concen-
nations (
crease from the mid-nineteenth century to 2100
trations and temperature. 12 But the major rea-
ative). T
is estimated to be 3.06°C in the market run. The
the conti
cooperative strategy lowers global temperature
carbon ta
by 0.22°C in 2100, whereas the noncooperative
II The projected temperature difference between the coop-
preted as
erative and market runs is 0.41°C in 2200 whereas that between
whether
the noncooperative and market runs is only 0.12°C in 2200.
12 More recent estimates of global warming show con-
through t
siderably less near-term warming than earlier estimates
The m
10 The climate model used in the RICE model is a cal-
(compare the current RICE with the 1992 DICE model).
through
ibrated version of the two-equation Schneider-Thompson
Recent evidence suggests that the cooling effects of sul-
that the :
model with an equilibrium temperature sensitivity coefficient
fates derived primarily from fossil-fuel emissions will
of 3°C for a doubling of CO₂ concentrations. The derivation
lower global mean temperature increases until the end of
nificantly
of the climate model is discussed in Nordhaus (1994).
the next century.
than doe
TE
1996
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
751
40
Market
solution
35
Noncooperative
e
equilibrium
30
Billion tons of carbon per year
25
Cooperative
equilibrium
20
FSU
DICE model
15
10
90
5
1990
2010
2030
2050
2070
2090
FIGURE 2. CO₂ EMISSIONS: DIFFERENT APPROACHES
siderably less
1, both com-
son for the small decrease in temperature
straightforward: when countries free-ride on
: reason that
between the market and cooperative runs is
the climate-change policies of other countries,
increase be-
that the high cost of control means that the
then they cut back their own efforts substan-
ket runs is so
economically efficient strategy is for only a
tially. Begin with the emissions control rates,
lag between
small reduction in CO₂ emissions.
shown in Figure 5. The global average rate of
ure increases
control of CO₂ is around 10 percent in the co-
grows over
B. Policy Variables
operative solution. This varies by region, with
oncentrations-
relatively high controls in China and the former
ut). 11 Addi-
We next examine the policy variables for
Soviet Union; for these regions, we estimate the
ecause of the
the different degrees of cooperation among
marginal costs of control to be relatively low.
CO₂ concen-
nations (market, noncooperative, and cooper-
For the efficient case, the lowest control rates
e major rea-
ative). The results are shown in terms of both
are in Japan and the European Union, which
the control rates for CO₂ emissions and the
are already relatively energy efficient and
carbon taxes. Carbon taxes should be inter-
where the marginal costs of controls are con-
:tween the coop-
preted as the marginal cost of control of CO₂
reas that between
sequently relatively high. According to the data
1.12°C in 2200.
whether these are efficiently implemented
used in the RICE model, the efficient control
ning show con-
through taxes, regulations, or tradable permits.
rates for 2000 range from 17 percent in China
arlier estimates
The major results are shown in Figures 5
to about 7 percent in Japan. The United States
2 DICE model).
through 9. The central finding of this study is
is in the middle of the pack, with an efficient
or effects of sul-
emissions will
that the noncooperative policies produce sig-
control rate of slightly below 9 percent. The
until the end of
nificantly lower control rates and carbon taxes
control rates rise over time as the marginal
than does global cooperation. The reason is
damages from CO₂ emissions rise. (Note that
752
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VO
1800
Market
solution
1600
Noncooperative
equilibrium
Concentrations (billions tons C)
1400
1200
Cooperative
1000
equilibrium
Change in temperature (degrees C)
1
DICE model
1
800
0
600
1990
2010
2030
2050
2070
2090
FIGURE 3. CO₂ CONCENTRATIONS
0.
these relative control rates would be roughly
with the average of 9.7 percent in the cooper-
proportional to those shown here if the overall
ative case. The reason for the lower control rate
level of controls were raised or lowered.)
is completely intuitive: it results from the free-
One immediate conclusion that comes from
riding wherein each nation ignores the impacts
under
this result is that current approaches to com-
of its CO₂ emissions on the welfare of other
erativ
bating global warming make no sense from the
nations (as well, of course, as assuming that
the C
point of view of pure economic efficiency. The
other nations' efforts are unaffected by its own
the g
current Framework Convention calls for major
self-interested behavior). The size of the free-
slight
emissions reductions in the OECD region with
riding effect is the major new result here.
cause
no immediate reductions in the developing
The second interesting conclusion in the
The f
countries-this being exactly the opposite of
noncooperative approach is the distribution of
case i
the efficient solution. The only potential ration-
control rates. This model predicts that the larg-
$5.94
ale for the Framework Convention is that it puts
est (albeit small) efforts will be taken by the
out, a
a very high weight on equity (by relieving poor
largest regions-particularly by the United
U.S. (
countries of obligations to reduce emissions)
States and the European Union. This predic-
The
and rules out the possibility of side payments
tion seems quite on the mark. It also correctly
higher
(say through allocation of emissions permits).
suggests that developing countries, particu-
policie
The control rates in the noncooperative solu-
larly small and poor countries such as Benin
weigh
tion are markedly lower (not shown but avail-
and Kyrgyzstan, will not be in the forefront of
operat
able from the authors). There are two major
global-warming politics.
the no
findings here. First, the aggregate global emis-
Figures 6 through 7 show the results for es-
distrib
sions control rate for the noncooperative equi-
timated carbon taxes. Looking first at Figure
erative
librium is in 2000 only 2.3 percent as compared
6, we can compare the aggregate carbon taxes
nonco
IS
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
753
3.5
Market
solution
3.0
*
2.5
Change in temperature (degrees C)
Noncooperative
2.0
equilibrium
DICE model
1.5
Cooperative
equilibrium
1.0
0.5
0.0
1990
2010
2030
2050
2070
2090
FIGURE 4. TEMPERATURE CHANGE
oper-
1 rate
free-
pacts
under different strategies. Note that the coop-
to have significantly more (but not very) strin-
other
erative RICE model looks quite similar to
gent controls as compared to small countries.
that
the older DICE model (which also found
The noncooperative carbon taxes are highest
own
the global optimum). The carbon tax starts
in the European Union ($0.86 per ton in 2000)
free-
slightly higher and grows more rapidly be-
and the United States ($0.65 per ton in 2000).
cause of the steeper trajectory for emissions.
The difference reflects the slightly larger out-
1 the
The first-period carbon tax in the cooperative
put in the European Union. For smaller coun-
on of
case is $6.19 per ton carbon in 2000 versus
tries, the tax rates are much smaller: 10 cents
larg-
$5.94 in the DICE model. (Here and through-
per ton in India, and only 1 cent per ton in the
y the
out, all dollar figures refer to prices in 1990
S4 group of countries.
nited
U.S. dollars at 1990 market exchange rates.)
It seems appropriate to conclude that outside
redic-
The cooperative tax rates are significantly
the United States, Europe, and Japan, the ra-
rectly
higher than the noncooperative or nationalistic
tional noncooperative strategy would be sim-
rticu-
policies for all regions and periods. The
ply to ignore global warming at the present
Benin
weighted average carbon tax for the nonco-
time. Even by the end of the 21st century, no
ont of
operative policy is 24 cents per ton carbon for
country acting in a noncooperative framework
the noncooperation equilibrium in 2000. The
would have carbon taxes above $2 per ton C.
or es-
distribution of carbon taxes for the noncoop-
If we define the "cooperation ratio" as the
Figure
erative policy is shown in Figure 7. For the
ratio of the noncooperative carbon tax to the
taxes
noncooperative strategies, large countries tend
cooperative carbon tax, we can calculate that
754
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VOI
0.25
China
0.20
FSU
0.15
Control rate by region
ROW
0.10
USA
Japan
Europe
Carbon tax (1990 dollars ner ton)
0.05
0.00
1990
2010
2030
2050
2070
2090
FIGURE 5. CO₂ CONTROL RATES:
COOPERATIVE SCENARIO
this ratio ranges from essentially zero in the
than those in the global cooperative strategies,
smallest countries to between 10 and 15 per-
some have expressed surprise that they are
sma
cent for the United States and Europe.
not even lower. The reason is that there are a
emis
What happens to the cooperation ratio over
few countries or regions (notably the United
and
time? According to our calculations, the de-
States, China, Japan, and Europe) which are
gain
gree of cooperation is expected to fall in the
large enough so that it is their own self interest
noncooperative solution. Cooperation in the
to reduce CO₂ emissions even ignoring the
Nash equilibrium decreases as the extent of
benefits to other countries. Were China to
inequality of country income falls. Hence, the
break up, were Europe to make decisions on a
W
extent of cooperation is calculated to decline
national level, or were the Republican Revo-
regi-
slightly over the next four decades as the share
lution in the United States to devolve environ-
latec
of the United States, Japan, and Europe declines
mental decisions to the states, the predicted
cons
and the distribution of economic sizes of nations
degree of cooperation would be even lower.
disc
becomes more equal. Greater equality leads to
There are a few other intriguing details of
fuse
smaller incentives to be a good global citizen.
the runs worth noting. China is definitely a key
eren
For small countries (with GDPs of under
player and exhibits a different pattern. Figure
equa
$20 billion) the noncooperative optimal con-
5 shows that China has the highest cooperative
in th
trol rates and carbon taxes are minuscule,
control rates of all the regions-this reflecting
cific
$0.01 per ton carbon versus $5.98 in the global
the relatively high CO₂ emissions per unit out-
year
cooperative case. While the taxes in the non-
put (see Table 2). But countries which are
these
cooperative strategies are significantly lower
hardly players today (India, China, and the
whic
190
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NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
755
30
Cooperative
equilibrium
25
Carbon tax (1990 U.S. dollars per ton)
20
15
DICE model
10
Noncooperative
Market
equilibrium
5
solution
0
1990
2010
2030
2050
2070
2090
FIGURE 6. AVERAGE CARBON TAXES
ies,
are
smaller developing countries) dominate CO₂
is assigned its optimal policy without any
e a
emissions by the middle of the next century
side payments from other countries. This is
ted
and will have to behave cooperatively if the
equivalent to each country receiving in the co-
are
gains from cooperation are to be realized.
operative equilibrium a quota of tradable emis-
rest
sions permits equal to the quantity of its own
the
C. Welfare Effects by Region
emissions.
to
The resulting impacts upon economic wel-
na
What are the overall economic effects by
fare are shown in Table 4. Note first that the
vo-
region? The gain to cooperation is calcu-
overall results from the cooperative RICE so-
on-
lated as the present value of the change in
lution are quite close to those of the original
ted
consumption valued using the region-specific
DICE model. The former is about one quarter
discount rates on consumption (not to be con-
higher because of the higher growth rates in
of
fused with the pure rates of social time pref-
the RICE model. By contrast, the noncooper-
tey
erence, or discount rates on utility, which are
ative, six-region RICE model shows extremely
are
equal across regions). The discount rates
slim net benefits-only $43 billion in dis-
ve
in this calculation are region and time spe-
counted benefits as opposed to $344 billion for
ng
cific, and they average about 4½ percent per
the cooperative RICE or $271 for the coop-
ut-
year (in real terms) over the next century. In
erative DICE model.
are
these runs, there are no international transfers,
Figure 8 shows the gains to different regions
the
which essentially means that each country
for the cooperative and noncooperative cases.
756
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
1.5
Europe
USA
S
M
Carbon tax (1990 U.S. dollars per ton C)
N
1.0
C
D
N
Japan
FSU
S}
0.5
S)
in
China
is
p
tl
St
a:
a:
0.0
p
1990
2010
2030
2050
W
re
FIGURE 7. NONCOOPERATIVE CARBON TAXES
d
S
M
Table 4 and Figure 8 present a number of sur-
benefits in the cooperative strategy because it
e)
prises in the regional results. The noncooper-
is required to undertake significant mitigation
CI
ative solution produces positive net benefits
efforts and has few benefits because of its
u
relative to the market solution for all regions.
northerly location. By contrast, the ROW re-
u
This result is expected because the noncoop-
gion reaps major net benefits from the coop-
a
erative policies improve welfare while the ex-
erative solution because the mitigation efforts
to
ternal interactions among countries are ones
are undertaken primarily in the high-income
a
that are beneficial relative to the market case.
countries early in time while the major benefits
The net benefits in the noncooperative case are
in terms of damages avoided accrue to the de-
sl
relatively uniform across the different regions,
veloping countries in several decades.
with most of the positive effects coming from
These results indicate that the cooperative
ci
the reductions in damage from climate change.
solution-one in which nations are allocated
The major surprise in these results is the lop-
emissions equals to their efficient emissions-
ai
sided benefits from the cooperative strategy.
might well not emerge as the outcome of a
The United States actually loses in the coop-
bargaining process in which nations will only
erative solution relative to the noncooperative
sign on to an agreement that improves their
equilibrium. The reason is that, with its rela-
economic welfare. Of course, the pattern of net
di
tively large emissions, the United States would
gains can in principle be altered through dif-
di
be slated to incur major costs today, while its
ferent schemes for allocating emissions rights
benefits would be relatively small given its de-
to countries (that is, by adding side payments
W
clining share of the world economy. Similarly,
to the program analyzed here); the gains and
re
the former Soviet Union has quite modest net
losses could be made much more equal over
p
El
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NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
757
TABLE 4-NET BENEFITS OF DIFFERENT STRATEGIES BY REGION RELATIVE TO THE MARKET EQUILIBRIUM
(BILLIONS OF 1990 U.S. DOLLARS, DISCOUNTED TO 1990)
Net benefits by region
European
Former Soviet
Rest of
Strategy
United States
Japan
China
Union
Union
world
Total
Market
0.0
0.0
0.0
0.0
0.0
0.0
0.0
Noncooperative
2.9
3.6
8.7
7.9
2.7
16.5
42.5
Cooperative
0.8
46.3
39.4
28.5
4.1
224.8
343.8
DICE (cooperative)'
na
na
na
na
na
na
271.0
Note: Each entry indicates the net benefits for a region relative to the market or uncontrolled strategy. NA is not available.
a From the aggregate DICE model in Nordhaus (1994).
space and time through different allocations or
market solution through different time periods.
side payments. Determining possible bargain-
For example, it shows that the United States
ing outcomes is, however, a difficult empirical
would have a cumulative discounted con-
issue that is outside the scope of the present
sumption loss from cooperation relative to the
paper and is the subject of current research by
market of $12 billion through 2050. The cal-
the authors. What this study examines is the
culation indicates that a cooperative global-
set of national emissions that is consistent with
warming accord would reduce the cumulative
an efficient allocations of emissions over space
discounted consumption of all countries ex-
and time. The interesting new result of this
cept Japan through 2050. The ROW region
paper is that a scheme with no side payments
suffers major losses, approaching a total of
will reduce the standards of living of all major
$100 billion by mid-century. Moreover, as can
regions for at least half a century and will re-
be seen by adding the numbers for the different
duce the discounted net welfare of the United
regions together, there is still a negative effect
States when all time periods are considered.
on cumulative global consumption by the mid-
Moreover, it is interesting to note that all the
dle of the next century.
use it
emission-rights allocations proposals that are
On a longer time scale (not shown), the
gation
currently under consideration are even more
ROW breaks even by the end of the next cen-
of its
unfavorable to the United States than the one
tury and is the major beneficiary after that
W re-
underlying the cooperative equilibrium and
point. The United States and the former Soviet
coop-
are therefore even less likely to be acceptable
Union experience a reduction in discounted
efforts
to high-income countries than the program ex-
cumulative consumption through the end of
icome
amined here.
the next century. All the curves are heading up
:nefits
What is the time profile of benefits? Figure 9
at the end of the period, and the discounted
he de-
shows the time paths of discounted cumulative
cumulative totals over the 250-year estimation
consumption in different regions. More pre-
period, shown in Table 4, are positive for all
rative
cisely, the numbers are the sum of the consump-
regions and quite large for the ROW region.
cated
tion differences between the cooperative strategy
The estimates of the regional costs and
ons-
and the market strategy from the beginning of
benefits in the RICE model are sensitive to pa-
of a
the period (1990) until the date shown on the
rameters of the mitigation-cost and climate-
only
horizontal axis. For each region, the consump-
damage functions, but the major determinant
their
tion figures are discounted back to 1990 and the
of the patterns is initial emissions and growth
of net
discount rate is the region-specific and variable
of output, which are considerably more secure
7 dif-
discount rate on consumption.
than the cost and damage estimates. The basic
rights
This figure shows the problem of global
dilemma is clear: the long period between
nents
warming in a nutshell. It indicates how each
emissions reductions and reduced climate dam-
and
region would experience the economic im-
age means that countries must be extraordi-
over
pacts of a cooperative strategy relative to the
narily farsighted. In addition, the pattern of
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THE AMERICAN ECONOMIC REVIEW
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VOL.
350
300
Gains (billions of 1990 U.S. dollars)
250
200
150
100
50
Difference in consumption (bill of dollars)
0
USA
JPN
CHN
EEC
FSU
ROW
World
Cooperative strategy
Noncooperative strategy
FIGURE 8. GAINS FROM CLIMATE-CHANGE POLICY:
COOPERATIVE AND NONCOOPERATIVE POLICIES (TOTAL GAINS DISCOUNTED TO 1990)
gains and losses, with the major long-run gains
uncertainties are often critical to determining
coming to developing countries while the net
policies, formal techniques for determining
benefits to the United States and the former
the uncertainty of future trajectories or of im-
199
Soviet Union are minimal, is a most surprising
pacts have been rarely applied to major policy
equa
and troubling finding.
issues.¹⁴
stan-
A full-scale analysis of the uncertainties as-
pres
D. Sensitivity Analysis
sociated with the RICE model-including un-
resp
certainty about model structure as well as
mod
To understand the full range of outcomes
about individual parameters-is beyond the
of th
and policy responses to the threat of global
scope of the current article. Many of the cen-
A),
warming, we must assess the fact that many of
tral uncertainties have been examined in the
it fr
the underlying processes are imperfectly un-
context of the DICE model (see Nordhaus,
subj
derstood. Social scientists have developed a
vatio
variety of tools to incorporate uncertainty into
quantitative modeling, and these can help put
bounds on potential future outcomes.¹³ Although
14 One notable and controversial example of the sys-
15
tematic application of statistical techniques is the Ras-
mapp
mussen report (Nuclear Regulatory Commission, 1975),
doger
which estimated the risk of accidents of different levels of
13 See M. Granger Morgan and Max Henrion (1990)
and I
severity in commercial nuclear power plants. An exem-
for a recent survey of tools for the analysis of uncertainty
certai
plary study used probabilistic assessments for ozone de-
in quantitative risk and policy analysis.
the
pletion (National Academy of Sciences, 1979).
50th
'BE
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
759
10
China
Japan
Europe
0
Difference in consumption (bill of dollars)
-10
USA
FSU
-20
-30
-40
Rest of World
-50
1990
2010
2030
2050
FIGURE 9. CUMULATIVE DISCOUNTED CONSUMPTION:
COOPERATIVE VERSUS MARKET STRATEGY (TOTAL GAINS FOR CONSUMPTION THROUGH
THE GIVEN DATE, DISCOUNTED BACK TO 1990)
nining
nining
of im-
1994 Chapters 6-8), and those results apply
in Nordhaus (1994 Table 6.1), and the reader
policy
equally well to the RICE model. To under-
is referred to that reference for a full discussion.
stand the extent of sensitivity of the model we
Figure 10 shows the results of the sensitivity
ies as-
present here a limited sensitivity analysis with
analysis. That figure shows the sensitivity of
respect to the important parameters of the
1g un-
three important variables in the cooperative
ell as
model. For each of the important parameters
equilibrium: the carbon tax in 2000, the effi-
d the
of the model (see the description in Appendix
cient reduction of CO₂ emissions in 2000, and
e cen-
A), we have varied the parameter by changing
the change in global mean temperature in
in the
it from the subjective 50th percentile to the
lhaus,
subjective 90th percentile. 15 The exact deri-
vation of the uncertainty range was developed
the sensitivity analyses, we estimate the (subjective) 90th
percentile of the distribution, Γ⁹⁰. Figure 10 shows the
ratio of different outcomes for the 90th percentile of a
ie sys-
15 Symbolically, we can represent the RICE model as a
variables to the 50th percentile of that variable; that is,
= Ras-
mapping, Y, = F(X, Γ), where Y, is the vector of en-
4 = F(X,-,; r⁵⁰, where Д, is the ratio of
1975),
dogenous and policy variables, X, is a vector of current
outcomes for variables of interest when varying the ith
vels of
and lagged exogenous variables, and Γ is the set of un-
parameter, Г.ˢ⁰ is the vector of Γ with all variables set at
exem-
certain parameters. The base run estimates outcomes for
their 50th percentile while Γ,⁹⁰ is the vector of parameters
ne de-
the "best-guess" parameters (Γ⁵⁰, which represents the
with all variables but the ith set at the 50th percentile while
50th percentile of the distribution of the parameters). In
the ith parameter is set at its 90th percentile.
760
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
4.1
2.0
1.5
Ratio of variable to base value
1.0
X
X
0.5
0.0
p Θ₁ 1 t1 (AA/A)₆ β t2 b₂ A. δₘ T₀ (AP/P)₂ T₀* M₀ δₖ b, σ₀
Parameter varied
X
Temperature (2100)
Carbon tax (2000)
Control rate (2000)
FIGURE 10. SENSITIVITY TESTS FOR PARAMETERS
Note: The variables on the horizontal axis are parameters of the RICE model as defined in Appendix A. The markers
indicate the ratio of the outcome variable in the sensitivity case to the outcome for the base case. The sensitivity cases
set the values of the variables at the subjective 90th percentile. The outcome variables are the optimal cooperative carbon
tax in 2000, the optimal cooperative reduction rate for CO₂ emissions in 2000, and global mean temperature in 2100.
2100. For each of the three variables, we have
variables are relatively unimportant for the
displayed in Figure 10 the ratio of the value of
results.
16
the variable in the sensitivity run to the value
In analyzing model sensitivity, it is easy to
of the variable in the base case.
become lost in the details. For policy purposes,
Figure 10 indicates that the results are ex-
however, the single most critical question is
tremely sensitive to the pure rate of social time
how an uncertainty affects current policy,
preference. The low rate of time preference
which is best seen in the effect on the carbon
(equal to 1 rather than 3 percent per year) in-
tax. By this standard, the two crucial parame-
creases the carbon tax by a factor of 4 and the
ters are the discount rate (which indicates the
control rate by a factor of almost 2. In addition,
the damage intercept (which is the fraction of
output lost from a doubling of atmospheric
16 These results parallel closely the findings of other
CO₂) leads to a marked increase in both the
studies on the sensitivity of policy to uncertainties about
carbon tax and the control rate. The other
major variables.
MB
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
761
relative importance of the future compared to
sions, and CO₂ concentrations as compared
the present) and the damages from climate
with the earlier DICE model is largely offset
change (which measure the willingness to
by revisions in estimated effects of other
pay to prevent or slow climate change). It is
greenhouse gases. As a result the estimated
interesting to note that both major uncer-
extent of global warming in the market case
tainties involve human preferences rather
by the year 2100-approximately 3°C-
than pure questions of "fact" about the nat-
differs little between the RICE model and
ural sciences.
other estimates.
Second, the efficient or cooperative policies
III. Conclusions
in the regional model confirm estimates made
in globally aggregated models, such as the
To summarize, this paper has presented the
DICE model. The best summary variable for
RICE model, which is a new dynamic, multi-
efficient controls is the carbon tax, which is
region, general-equilibrium model of climate
calculated to be about $6 per ton carbon in
and the economy. It differs from earlier work,
2000, a number that is virtually identical to
which focussed on a globally aggregated ap-
estimates for the efficient policy in the DICE
proach, by introducing production, consump-
model. 18 The estimated degree of control in the
tion, emissions, and damages for different
RICE model is, however, estimated to grow
regions. This approach compares three differ-
somewhat more rapidly than in the DICE and
ent strategies for the control of global warm-
other models, with estimated efficient carbon
ing: a market approach in which no climate
taxes at the end of the next century near $27
change policies are taken, a global coopera-
per ton carbon.
tive approach in which all countries choose
Third, the RICE model provides estimates
climate-change policies to maximize global in-
of the efficient control rates in different
σ₀
comes, and a noncooperative or nationalistic
regions as well. In the efficient solution, car-
approach in which each country takes policies
bon taxes are identical in all regions. The con-
to maximize its own national income. These
trol rates will differ, however, because of
results are tentative and subject to revision.
different costs of reducing CO₂ emissions. The
2000)
Further work will be necessary to test their ro-
estimates presented here indicate that the ef-
bustness against alternative assumptions, to
ficient emissions control rates will be highest
appraise the results for different coalitions, and
in China and the former Soviet Union and low-
: markers
to compare the results against other models.
est in Japan and Europe, with the differences
vity cases
ive carbon
Subject to these reservations, the following are
being at least a factor of two. These results
a 2100.
the major conclusions.
indicate that there will be substantial ineffi-
First, the model produces results for the
ciencies in any policy (such as that currently
baseline (market or uncontrolled) which dif-
in force under the Framework Convention)
fer significantly from other projections. 17
that equalizes emissions control rates across
Output and emissions in the RICE model are
countries or does not allow trading of emis-
for the
estimated to grow much more rapidly than
sions permits.
in the DICE model or than in many inter-
Fourth, a major contribution of this study
easy to
national projections (such as that of the In-
is to estimate the difference between the ef-
irposes,
tergovernmental Panel on Climate Change).
ficient policy and the noncooperative policy.
stion is
The more rapid growth comes largely from
The noncooperative or nationalistic policy
policy,
a view of the growth process in which there
is one in which countries maximize their
carbon
is considerable but incomplete convergence
economic welfare taking policies of other
arame-
of per capita incomes of countries. The
countries as given. This implies that small
ates the
higher projected growth of output, emis-
countries, whose climate-change policies
have little effect on their own economic
of other
17 In the discussion that follows, the results for the
:es about
DICE model refer to DICE-123 as presented in Nordhaus
18 All dollar figures refer to prices in 1990 U.S. dollars
(1994).
at 1990 market exchange rates.
762
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VC
welfare, will have little incentive to reduce
Japan show reductions in cumulative dis-
emissions while the largest countries will
counted consumption until after the middle
A,
Pᵢ¹
have greatly attenuated incentives to engage
of the next century.
i
in costly reductions in CO₂ emissions. The
Seventh, the results indicate that there are
O(
calculations here indicate that the controls in
major gains to taking an efficient cooperative
the noncooperative case (as measured by the
approach to coping with global warming as
average rate of carbon tax) will be only 1/25 of
opposed to the noncooperative approach. We
the level of the cooperative case. That is, while
estimate that the net economic gain from an
α
the average carbon tax in 2000 is estimated
efficient policy has a discounted value of $344
b₁,
to be about $6 per ton carbon in the coop-
billion relative to the market scenario, while
ß =
€
erative case, it is calculated to be about $0.24
the noncooperative policy has a gain of only
γ
per ton in the noncooperative case. More-
$43 billion. Hence, there are clear gains to at-
δₖ
over, the divergence between the coopera-
taining a cooperative policy (assuming, of
δₘ
tive and the noncooperative policies is
course, that the policy is itself efficient). The
I
A =
calculated to increase over time as the in-
gains from cooperation would be even larger
t
equality of county sizes decreases, and this
if climate change proved to have catastrophic
P =
divergence would increase further if large
consequences that are very unevenly felt across
(
countries like China, India, Russia, Canada
nations.
T1,
f
or the United States splinter into smaller
In sum, the results of this new integrated
F
countries or decision-making units.
model of climate and the economy empha-
-
Fifth, these results indicate that the stakes in
sizes the implications of the fact that while
01,
controlling global warming are modest in the
climate change is a global externality, the
context of overall economic activity over the
decision makers are national and relatively
next century. If our estimates are accurate,
small. These inherent difficulties involved in
they indicate that the losses from global warm-
planning over a horizon of a century or more
Cᵢ(
about so uncertain and complex a phenom-
cᵢ(
ing will be in the range of 1 to 2 percent of
CA
global income over the next century. The net
enon are compounded by the dispersed na-
Dᵢ(
costs (that is, climate-change damages less
ture of the decisions and the strong tendency
E,(
mitigation costs) can be reduced by perhaps
for free-riding by nonparticipants in any
EX
1/3 percent of income by a judicious choice
global agreement. Countries may therefore
F(1
c
of climate-change policies-although, to be
be triply persuaded not to undertake costly
Ω,(
sure, the impact is much greater on our de-
efforts today-first because the benefits are
a
scendants than on ourselves. According to
so conjectural, secondly because they occur
Kᵢ(
RICE, successful cooperation would lead to
so far in the future, and third because no in-
IM,
dividual country can have a significant im-
M(
net gains, but the failure to cooperate is un-
ii
likely to lead to economic disaster over the
pact upon the pace of global warming. The
NF.
next century.
present study indicates that the third of these,
Φᵢ
Sixth, the pattern of gains and losses
the dispersed nature of the decision making
Qi(
from different strategies is quite surprising.
and the consequent diluted incentives to act,
R(1
T(t
All countries gain from the noncooperative
is a powerful hindrance to setting efficient
1.
approach, although the amount of gain is
climate-change policies.
T*(
relatively small. The net gains from coop-
lo
eration without international transfers are
APPENDIX A: EQUATIONS OF THE RICE MODEL
uᵢ(₁
W
quite unevenly distributed, with the major
This appendix gives the details of the RICE model. We
S
gains accruing to developing countries with
first list and define the variables and then provide the com-
Y,(;
low and rapidly growing emissions. High-
plete equation listing.
d
income countries have but modest gains to
cooperation, but the United States actually
1. Variables
loses from cooperating relative to a nonco-
The variables are as follows. In the listing, 1 always
operative strategy. In addition, the time path
1
refers to time (1 = 1990, 2000, ...) while i refers to the
of gains and losses indicates that even in
1,(1
region (i = 1, , n = USA, Japan, Europe, ...). The
the cooperative scenario, all regions except
regional definition is given in Appendix B.
VOL. 86 NO. 4
NORDHAUS AND YANG: CLIMATE-CHANGE STRATEGIES
763
Exogenous Variables.
2. Equations
A,(t) = level of technology
P₁(t) = population at time 1, also proportional to labor
(A1)
inputs
O(t) = forcings of exogenous greenhouse gases
=
E E
Parameters.
subject to
a = elasticity of marginal utility of consumption
b1.1, b₂ = parameters of emissions-reduction cost function
(A2)
ß = marginal atmospheric retention ratio of CO₂
emissions
(A3)
γ = elasticity of output with respect to capital
δₖ = rate of depreciation of the capital stock
(A4)
=
Sm = rate of transfer of CO₂ from atmosphere to other
reservoirs
À = feedback parameter in climate model (inverse to
temperature-sensitivity coefficient)
P = pure rate of social time preference
σ₁(t) = CO₂ emissions/output ratio
T1, T2, T3, T4 = parameters of climate equation (T₁ is a
(A5)
function of the heat capacity of the atmosphere and up-
per ocean while T2 depends upon the turnover time be-
(A6)
tween the upper ocean and the deep ocean)
Θ₁,, Θ₂ = parameters of climate damage function
(A7)
S
Endogenous Variables.
C,(t) = total consumption
(A8)
c₁(t) = per capita consumption
CA, (t) = current account balance
(A9)
T(t) = T(t - 1)
D,(t) = damage from greenhouse warming
E,(t) = CO₂ emissions
+
EXᵢ,(t) = exports from region i to region j
F(t) = radiative forcing from all greenhouse gas
concentrations
Ωᵢ(t) = output scaling factor due to emissions controls
(A10)
and to damages from climate change
K,(t) = capital stock
IMᵢ.ⱼ(t) = imports from region i to region j
(All) = 4.1 log[ M(t)/M(0)} log(2) + 0(t)
M(t) = increase in mass of CO₂ in atmosphere from pre-
industrial level
NFA, (t) = net foreign assets of country i
(A12) 1 i=1,2,...,n.
Φ, = welfare weight on country i
Q,(t) = gross domestic or regional product
R(t) = net rate of return on capital
Σ γQ,(t)
T(t) = atmospheric temperature relative to preindustrial
(A13)
level
T*(t) = deep ocean temperature relative to preindustrial
level
(A14) NFA₁(t) =NFA(t -1)+ CA(r- 1)
uᵢ(t) = u,[c,(t)] = utility of per capita consumption
W = social welfare function determined by country con-
(A15)
sumption levels
"
Y, (t) = gross national or regional product (net of climate
damage and mitigation costs)
(A16) -CA;(t) ≤ 0.1Q,(t)
(A17) -NFA,(1) ≤ 0.1Q,(t) â
Policy Variables.
I,(t) = gross investment
(A18) â
(t) = rate of emissions reduction
764
THE AMERICAN ECONOMIC REVIEW
SEPTEMBER 1996
VI
G:
APPENDIX B: REGIONAL GROUPING IN THE RICE MODEL
Number of
Gross domestic product
Population, 1990
CO₂ emissions, 1990
Country or group
countries
(millions of 1990 US $)
(thousands)
(millions of tons C)
In
1) United States
1
5,464,796
250,372
1,370.0
2) Japan
1
2,932,055
123,537
291.5
3) Former Soviet Union
1
855,207
289,324
1,065.7
4) China
1
370,024
1,133,683
805.5
5) Europe
1
6,828,042
366,497
872.3
6) Huge
1
295,760
849,515
215.4
In
7) Large
2
586,072
327,274
593.0
8) Midsized
11
2,155,910
442,370
789.7
9) Small
38
1,272,414
876,027
1,212.0
10) Tiny
137
318,464
607,503
623.9
M
Total
21,078,746
5,266,102
7,839.1
Bottom 5 groups (ROW)
4,628,621
3,102,689
3,434.0
Selected countries in groups 6 through 10:
M
Gross domestic product
Population, 1990
CO₂ emissions, 1990
Code
Country
(millions of 1990 US $)
(thousands)
(millions of tons C)
SI
India
295,760
849,515
215.4
S2
Brazil
479,214
149,042
317.1
Indonesia
106,859
178,232
275.9
S3
Canada
566,694
26,522
127.6
Australia
296,053
17,045
72.1
Mexico
244,046
81,724
144.1
Argentina
141,353
32,322
33.1
M
Turkey
108,447
56,098
35.3
South Africa
101,963
37,959
78.0
S4
Venezuela
48,599
19,325
43.0
Romania
37,625
23,200
59.4
M
Nigeria
35,460
96,203
95.9
Egypt
35,400
52,426
22.3
Slovenia
17,331
2,000
4.8
S5
Kenya
8,675
24,160
5.0
Iceland
6,024
255
0.5
Honduras
2,944
5,105
12.0
N:
Maldives
174
214
0.0"
Anguilla
23
7
0.0"
Tuvalu
5
9
0.0"
a Less than 50,000 tons per year.
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