Suzi Kerr Motu and Adam MillardBall McGill Motu climate change economics workshop March 2012 The challenge We need DCs to mitigate to meet targets We want DCs to mitigate to lower costs ID: 591784
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Slide1
Cooperation to reduce developing country emissions
Suzi Kerr (Motu) and Adam Millard-Ball (McGill)
Motu climate change economics workshop, March, 2012Slide2
The challenge
We
need
DCs to mitigate to meet targets
We want DCs to mitigate to lower costsButDCs have insufficient concern and capability / capacity Need to transfer resourcesExisting instruments – e.g. offsets - have serious flawsHow can we do better?Slide3
Outline
Cooperation within a repeated game
Mitigation instruments
Challenges
Straw manFuture Research DirectionsSlide4
Gains from cooperation
M
IC
M
DC
H
MB
DC
MB
IC
MB
IC+DC
MC
IC
MC
DC
MC
IC+DC
Most gains to industrialised country
Most cost to developing countrySlide5
Can we achieve this?
Nash equilibrium (e.g. Barrett) very negative
More optimistic in a repeated game
Experimental evidence that people are altruistic and conditional cooperators – states?
Good monitoring, low discount rates make cooperation possibleSome countries will lead to generate trustbutBargaining will generate delay – difficult to identify bargaining space and agree on an equilibriumNeed flexibility in cost sharing to find mutually beneficial deals.Slide6
A Continuum of Mechanisms
6
Tradable credits
E.g. CDM
Grants and loansE.g. GEFGHG reductions only
Integrated with cap-and-trade
Results based
Ex-post monitoring and payment
Broader development goals
No link to
cap-and-trade
Effort based
Ex-ante assessment and payment
Non-financial approaches: technology transfer, capacity buildingSlide7
Common Challenges
Leakage
Adverse selection
Risk and moral hazard
Incomplete contracts/underinvestmentNegotiationIntegration with cap and tradeMost challenges apply to all instruments on the continuum, not just offsetsSlide8
Adverse Selection
Information asymmetries between ‘regulator’ and offset provider combined with voluntary
participationSlide9
Adverse SelectionSlide10
Adverse Selection
Considerable evidence that adverse selection is a major problem in CDM
Admissions by project developers
Manipulation of Internal Rate of Return
Non-credible claims about barriersImplausibility of aggregate claimsSimulation / econometric modelsTechnology diffusion modelsSlide11
Adverse Selection
Possible solutions:
Reduce private information
Conservativeness and discounting
Adjust the cap or fund size – or give up and reward allScale upe.g. Domestic cap and trade in DC with binding capSlide12
Risk and moral hazard
baseline
response
emissionsSlide13
baseline
response
emissions
Baseline risk
Improve baseline
Allow baseline to change
If fn(DC action) leads to moral hazard
Moral hazard: when contract is insufficiently precise (possibly because of unobservable effort) so that what the parties explicitly agree to do in the contract is not exactly the intention of both parties.Slide14
baseline
response
emissions
Response
risk
Improve responses
Reward actions rather than emissions
Offset cost of actions
No incentive for ‘invisible’ actionsSlide15
Other
risk management options
Industrialised country direct investment
IC takes some response risk
If brings extra resources makes response larger and reduces relative baseline risk‘No loss’ baselinesRemoves risk of absolute liability onlyMakes effective price
θ
p – where
θ
=
prob
of reward
Response is lower and relative risk higher.Slide16
Hold-up and underinvestment
Effective mitigation requires:
long-term investment,
innovation,
policy change and structural changeOnce investments are made, the DC has little bargaining power during renegotiation they will be unwilling to invest.Slide17
Solutions to hold-up
IC makes direct equity investments in mitigation
Directly addresses under-investment
Bargaining becomes more balanced
Commitment is visible so less under-investmentHas benefits for risk sharing alsoBuild IC credibility for cooperationSlide18
Straw man
Monitor (and model to assess effort)
2. Differentiate policies depending on the DC
For ‘strong’ countries – based on governance not income
Agree (bi- or multilaterally) combination of target/pledge and investment packagePay (in cash or tradable credits with commitment to purchase) relative to target Slide19
For ‘weak’ countries
If possible create regional or sectoral targets with results-based agreements
Invest in policy, technology, capital and infrastructure
Try to get maximum benefit for funds
Be clear about aid objectivesDo not link to cap and trade marketsMake graduation to national emissions contracts attractive Internalise carbon costs from IC end – through capital and consumer marketsSlide20
Future Research Directions
Potential
Model realistic mitigation instruments rather than ideal
Leakage
Estimates of intertemporal leakage/persistenceSlide21
Future Research Directions
Risk and additionality
Better estimates of real uncertainty in emissions projections for DCs and the drivers of that uncertainty
More out-of-sample tests of predictions
Integration with cap and tradeEvaluate costs and benefits of linking markets under uncertaintySlide22
Future Research Directions
Develop new mitigation instruments
More rigorous evaluation of actual mitigation investments and policies in developing countries
Theory-based design and simulation of complete policies under uncertainty
‘Experiments’ in small countries/regions