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9. Policy mechanisms

What policy mechanisms are available to address the climate problem? Major options include:

• Taxes and allowance trading — Either a tax or an allowance trading scheme puts a price on carbon emissions. How high should it be? How should it be designed? How should the tax revenues or the value of the allowances be allocated?
• Public investment — What other government initiatives are needed? How can the public sector effectively intervene to reduce emissions and stimulate new research and development?

 

Global refunding and climate change
Gersbach, H. & Winkler, R.
Journal of Economic Dynamics and Control, 2012, 36, 1775 - 1795
We design a global refunding scheme as a new international approach to address climate change. Participating in the global refunding system requires an initial payment. It allows each country to set its carbon emission tax, while aggregate tax revenues are partially refunded to member countries in proportion to the relative emission reductions they achieve within a given period. The refunding scheme reduces the intertemporal climate change problem into a static public goods problem. In a simple model we show that a suitably designed global refunding scheme achieves the social global optimum, provided that all countries participate. We discuss several procedures to achieve initial participation.

Influencing behaviour: The mindspace way
Dolan, P.; Hallsworth, M.; Halpern, D.; King, D.; Metcalfe, R. & Vlaev, I.
Journal of Economic Psychology, 2012, 33, 264 - 277
The ability to influence behaviour is central to many of the key policy challenges in areas such as health, finance and climate change. The usual route to behaviour change in economics and psychology has been to attempt to "change minds" by influencing the way people think through information and incentives. There is, however, increasing evidence to suggest that "changing contexts" by influencing the environments within which people act (in largely automatic ways) can have important effects on behaviour. We present a mnemonic, MINDSPACE, which gathers up the nine most robust effects that influence our behaviour in mostly automatic (rather than deliberate) ways. This framework is being used by policymakers as an accessible summary of the academic literature. To motivate further research and academic scrutiny, we provide some evidence of the effects in action and highlight some of the significant gaps in our knowledge.

Atmospheric externalities and environmental taxation
Sandmo, A.
Energy Economics, 2011, 33, Supplement 1, S4 - S12
The paper reviews the theory of environmental taxation under first best and second best conditions. It argues that negative environmental externalities lead to reductions of the provision of public goods, while investment in abatement increases the supply of public goods. Together with optimal tax rules, the paper therefore also derives conditions for the optimal use of resources on abatement. After brief discussions of the dimensions of time and uncertainty, tax reform and the double dividend, and taxes vs. quotas, the optimal tax model is applied to the problem of global warming with a discussion of the particular incentive problems that arise in designing and implementing global climate policy.

Polycentric systems and interacting planetary boundaries -- Emerging governance of climate change-ocean acidification-marine biodiversity
Galaz, V., Crona, B., Österblom, H., Olsson, P. & Folke, C.
Ecological Economics, 2012, 81, 21 - 32
Planetary boundaries and their interactions pose severe challenges for global environmental governance due to their inherent uncertainties and complex multi-scale dynamics. Here we explore the global governance challenge posed by planetary boundaries interactions by focusing on the role of polycentric systems and order, a theoretical field that has gained much interest in the aftermath of claims of a stagnant UN-process. In the first part we work toward a clarification of polycentric order in an international context, and develop three propositions. We then present a case study of the emergence of international polycentricity to address interacting planetary boundaries, namely the climate change, ocean acidification and loss of marine biodiversity complex. This is done through a study of the Global Partnership on Climate, Fisheries and Aquaculture (PaCFA) initiative. As the case study indicates, a range of mechanisms of polycentric order (ranging from information sharing to coordinated action and conflict resolution) operates at the international level through the interplay between individuals, international organizations and their collaboration patterns. While polycentric coordination of this type certainly holds potential, it is also vulnerable to internal tensions, unreliable external flows of funding, and negative institutional interactions.

Can Earth system interactions be governed? Governance functions for linking climate change mitigation with land use, freshwater and biodiversity protection
Nilsson, M. & Persson, Å.
Ecological Economics, 2012, 75, 61 - 71
Earth system interactions, as highlighted by the planetary boundaries framework, occur within and across natural, social and economic systems and shape global environmental change. This paper addresses the multi-level governance problem of coherently addressing key interactions between four Earth sub-systems -- climate change, freshwater use, land use and biodiversity -- taking into account concerns over problem shifting. After discussing possibilities for regional downscaling of the boundaries, we explore challenges for the EU region to coherently address this particular set of interacting Earth sub-systems and reduce the risk of problem shifting. This analysis demonstrates that Earth system interactions can be governed, but that they likely require comprehensive packages of governance responses across both sub-systems and levels. Three overarching governance functions are tentatively identified that directly or indirectly address Earth system interactions: reduction of system stress, risks and vulnerabilities; triggering and navigation of transformation of economic activity; and development of a diversity of options. Finally, the paper briefly discusses political and institutional challenges for developing, enabling and stabilising these governance functions.

Carbon motivated regional trade arrangements: Analytics and simulations
Dong, Y. & Whalley, J.
Economic Modelling, 2011, 28, 2783 - 2792
This paper presents both analytics and numerical simulation results relevant to proposals for carbon motivated regional trade agreements summarized in Dong and Whalley (2010). Unlike traditional regional trade agreements, by lowing tariffs on participant's low carbon emission goods and setting penalties on outsiders to force them to join such agreements, carbon motivated regional trade agreements reflect an effective merging of trade and climate change regimes, and are rising in profile as part of the post 2012 Copenhagen UNFCC negotiation. By adding country energy extraction cost functions, we develop a multi-region general equilibrium structure with endogenously determined energy supply. We calibrate our model to business as usual scenarios for the period 2006-2036. Our results show that carbon motivated regional agreements can reduce global emissions, but the effect is very small and even with penalty mechanisms used, the effects are still small. This supports the basic idea in our previous policy paper that trade policy is likely to be a relatively minor consideration in climate change containment.

Distributional effects of taxing transport fuel
Thomas Sterner
Energy Policy, in press
This paper takes as its starting point the observation that fuel prices – and thus taxes – are important for good management of climate change and other environmental problems. To economists this should be no surprise yet it seems that the role of fuel taxation as an instrument of climate policy has not been fully appreciated. It is however one of the few policy instruments that, since several decades, has actually reduced fuel consumption appreciably. Thanks to taxation (mainly in Europe and Japan), carbon emissions are considerably lower than they would have been otherwise. In future where carbon emissions are to be cut drastically, this instrument will be crucial. There is however much opposition to the instrument. This opposition uses various arguments, for instance that fuel taxes hurt the poor since they are strongly regressive. We however find that the choice of country and methodology turns out to be of great consequence. We study seven European countries—France, Germany, United Kingdom, Italy, Serbia, Spain and Sweden and do find some evidence of regressivity but the evidence is very weak. It does not apply when lifetime income is used and it does not apply to the poorest country in the group. The best one-line summary is probably that the tax is approximately proportional.

Ozone and PM related health co-benefits of climate change policies in Mexico
Douglas Crawford-Brown, Terry Barker, Annela Anger, Olivier Dessens
Environmental Science & Policy (2012) (17): 33-40
This paper reports the results of extending a previous analysis of reductions in ozone exposures resulting from greenhouse gas reduction policies in Mexico, to the case of estimating reductions in premature death and risks of non-fatal diseases following reductions in both ozone and particulate matter exposures. The results show that a policy of greenhouse gas reduction in the Mexican economy by 77% relative to a baseline growth scenario results in reduced mortality loss of almost 3000 lives per year. The benefit in terms of non-fatal disease is 417,000 cases reduced per year, at a savings of $0.6B per year in cost of illness. These reductions in human health risk, stemming from co-benefits of climate change policies, are significant in light of targets of risk reduction typically used in environmental regulatory decisions, and would be considered important drivers of policy choice if climate policy were harmonised with other areas of risk-based environmental policy.

Climate policies for road transport revisited (I): Evaluation of the current framework
Felix Creutzig, Emily McGlynn, Jan Minx and Ottmar Edenhofer.
Energy Policy (2011) 39(5): 2396-2406.
The global rise of greenhouse gas (GHG) emissions and its potentially devastating consequences require a comprehensive regulatory framework for reducing emissions, including those from the transport sector. Alternative fuels and technologies have been promoted as a means for reducing the carbon intensity of the transport sector. However, the overall transport policy framework in major world economies is geared towards the use of conventional fossil fuels. This paper evaluates the effectiveness and efficiency of current climate policies for road transport that (1) target fuel producers and/or car manufacturers, and (2) influence use of alternative fuels and technologies. With diversifying fuel supply chains, carbon intensity of fuels and energy efficiency of vehicles cannot be regulated by a single instrument. We demonstrate that vehicles are best regulated across all fuels in terms of energy per distance. We conclude that price-based policies and a cap on total emissions are essential for alleviating rebound effects and perverse incentives of fuel efficiency standards and low carbon fuel standards. In tandem with existing policy tools, cap and price signal policies incentivize all emissions reduction options. Design and effects of cap and trade in the transport sector are investigated in the companion article (Flachsland et al., in this issue).

Climate policies for road transport revisited (II): Closing the policy gap with cap-and-trade
Christian Flachsland, Steffen Brunner, Ottmar Edenhofer and Felix Creutzig
Energy Policy (2011) 39(4): 2100-2110.
Current policies in the road transport sector fail to deliver consistent and efficient incentives for greenhouse gas abatement (see companion article by Creutzig et al., in press). Market-based instruments such as cap-and-trade systems close this policy gap and complement traditional policies that are required where specific market failures arise. Even in presence of strong existing non-market policies, cap-and-trade delivers additional abatement and efficiency by incentivizing demand side abatement options. This paper analyzes generic design options and economic impacts of including the European road transport sector into the EU ETS. Suitable points of regulation are up- and midstream in the fuel chain to ensure effectiveness (cover all emissions and avoid double-counting), efficiency (incentivize all abatement options) and low transaction costs. Based on year 2020 marginal abatement cost curves from different models and current EU climate policy objectives we show that in contrast to conventional wisdom, road transport inclusion would not change the EU ETS allowance price. Hence, industrial carbon leakage induced by adding road transport to the EU ETS may be less important than previously estimated.

Technology diffusion under contraction and convergence: A CGE analysis of China
Michael Hübler
Energy Economics (2011) 33(1): 131-142.
This paper introduces a mechanism of international technology diffusion via FDI and imports into recursive-dynamic CGE modeling for climate policy analysis. As a novel feature, the mechanism distinguishes spillovers from foreign to domestic capital within sectors and across sectors within the production chain. The paper applies the mechanism to the analysis of a contraction and convergence type climate policy focusing on China. The mechanism of international technology diffusion leads to an increase in China's energy productivity an a decline in China's economic growth rates in a convergence process. In this case, inter-regional emissions trading could (more than) compensate China's welfare losses due to climate policy. Otherwise, China's welfare losses due to climate policy could be significant.

Design and implementation of carbon cap and dividend policies
Catherine M. Kunkel and Daniel M. Kammen
Energy Policy (2011) 39(1): 477-486.
An important concept in discussions of carbon management policies is cap and dividend, where some fraction of the revenues of an auction on emission allowances is returned to citizens on an equal per capita basis. This policy tool has some important features; it emphasizes the fact that the atmosphere is a common property resource, and it is a highly transparent measure that can be effectively used to protect the income of low-income individuals. In this paper we examine this policy in the California context, and focus on the costs and impacts of a cap and dividend scheme when applied to carbon emissions associated with electricity, natural gas and transportation services. We find that cap and dividend can effectively be used to address the economic impacts of carbon management policies, making them progressive for the lowest-income members of society. We find that the majority of households receive positive net benefits from the policy even with the government retaining half of the auction revenue. If auction revenues are instead dedicated only to low-income households, the majority of low-income households can be fully compensated even with the state government retaining upwards of 90% of auction revenues for other purposes.

Pushing the boundaries of climate economics: critical issues to consider in climate policy analysis
S. Serban Scrieciu, Terry Barker, Frank Ackerman
Ecological Economics, Available online 17 November 2011
Climate policy choices are influenced by the economics literature which analyses the costs and benefits of alternative strategies for climate action. This literature, in turn, rests on a series of choices about: the values and assumptions underlying the economic analysis; the methodologies for treating dynamics, technological change, risk and uncertainty; and the assumed interactions between economic systems, society and the environment, including institutional constraints on climate policy. We identify and discuss such critical issues, pushing at the boundaries of current climate economics research. New thinking in this area is gathering pace in response to the limitations of traditional economic approaches, and their assumptions on economic behaviour, ecological properties, and socio-technical responses. We place a particular emphasis on the role of induced technological change and institutional setups in shaping cost-effective climate action that also promotes economic development and the alleviation of poverty.

Economic feasibility of the path to zero net carbon emissions
Stephen J. DeCanio and Anders Fremstad
Energy Policy (2011) 39(3): 1144-1153.
The United States and other developed countries currently and historically have transferred considerable resources overseas to further their foreign policy objectives and to purchase oil and natural gas. These transfers are comparable in magnitude to estimates of the scale of the economic effort that would be required to create a world-wide energy system with zero carbon emissions by the middle of this century. Solar energy, the most abundant of the alternative energy supply sources, is currently the most expensive of the alternatives to fossil fuels but a substantial body of research and practical experience suggests that solar costs could fall to competitive levels with sufficient technological progress and increases in solar energy production and capacity.

When do increasing carbon taxes accelerate global warming? A note on the green paradox
Ottmar Edenhofer and Matthias Kalkuhl
Energy Policy (2011) 39(4): 2208-2212.
The "green paradox" by Hans–Werner Sinn suggests that increasing resource taxes accelerate global warming because resource owners increase near-term extraction in fear of higher future taxation. In this note we show that this effect does only occur for the specific set of carbon taxes that increase at a rate higher than the effective discount rate of the resource owners. We calculate a critical initial value for the carbon tax that leads to a decreased cumulative consumption over the entire (infinite) time horizon. Applying our formal findings to carbon taxes for several mitigation targets, we conclude that there is a low risk of a green paradox in case the regulator implements and commits to a permanently mal-adjusted tax. This remaining risk can be avoided by emissions trading scheme as suggested by Sinn—as long as the emission caps are set appropriately and the intertemporal permit market works correctly.

The implications of climate policy for the impacts of climate change on global water resources
Nigel W. Arnell, Detlef P. van Vuuren and Morna Isaac
Global Environmental Change (2011) 21(2): 592-603.
This paper assesses the implications of climate policy for exposure to water resources stresses. It compares a Reference scenario which leads to an increase in global mean temperature of 4 °C by the end of the 21st century with a Mitigation scenario which stabilises greenhouse gas concentrations at around 450 ppm CO2e and leads to a 2 °C increase in 2100. Associated changes in river runoff are simulated using a global hydrological model, for four spatial patterns of change in temperature and rainfall. There is a considerable difference in hydrological change between these four patterns, but the percentages of change avoided at the global scale are relatively robust. By the 2050s, the Mitigation scenario typically avoids between 16 and 30% of the change in runoff under the Reference scenario, and by 2100 it avoids between 43 and 65%. Two different measures of exposure to water resources stress are calculated, based on resources per capita and the ratio of withdrawals to resources. Using the first measure, the Mitigation scenario avoids 8–17% of the impact in 2050 and 20–31% in 2100; with the second measure, the avoided impacts are 5–21% and 15–47% respectively. However, at the same time, the Mitigation scenario also reduces the positive impacts of climate change on water scarcity in other areas. The absolute numbers and locations of people affected by climate change and climate policy vary considerably between the four climate model patterns.

Designing carbon markets. Part I: Carbon markets in time
Samuel Fankhauser and Cameron Hepburn
Energy Policy (2010) 38(8): 4363-4370.
This paper analyses the design of carbon markets in time (i.e., intertemporally). It is part of a twin set of papers that ask, starting from first principles, what an optimal global carbon market would look like by around 2030. Our focus is on firm-level cap-and-trade systems, although much of what we say would also apply to government-level trading and carbon offset schemes. We examine the "first principles" of temporal design that would help to maximise flexibility and to minimise costs, including banking and borrowing and other mechanisms to provide greater carbon price predictability and credibility over time.

Designing carbon markets. Part II: Carbon markets in space
Samuel Fankhauser and Cameron Hepburn
Energy Policy (2010) 38(8): 4381-4387.
This paper analyses the design of carbon markets in space (i.e., geographically). It is part of a twin set of papers that, starting from first principles, ask what an optimal global carbon market would look like by around 2030. Our focus is on firm-level cap-and-trade systems, although much of what we say would also apply to government-level trading and carbon offset schemes. We examine the "first principles" of spatial design to maximise flexibility and to minimise costs, including key design issues in linking national and regional carbon markets together to create a global carbon market.

Optimal timing of climate change policy: Interaction between carbon taxes and innovation externalities
Reyer Gerlagh, Snorre Kverndokk and Knut Einar Rosendahl
Environmental and Resource Economics (2009) 43(3): 369-390
This paper addresses the impact of endogenous technology through research and development (R&D) on the timing of climate change policy. We develop a model with a stock pollutant (carbon dioxide) and abatement technological change through R&D, and we use the model to study the interaction between carbon taxes and innovation externalities. Our analysis shows that the timing of optimal emission reduction policy strongly depends on the set of policy instruments available. When climate-specific R&D targeting instruments are available, policy has to use these to step up early innovation. When these instruments are not available, policy has to steer innovation through creating demand for emission saving technologies. That is, carbon taxes should be high compared to the Pigouvian levels when the abatement industry is developing. Finally, we calibrate the model in order to explore the magnitude of the theoretical findings within the context of climate change policy.

Rethinking Global Climate Change Governance
Scott Barrett
Economics: The Open-Access, Open-Assessment E-Journal (2009) 3(5): 1-12.
This paper explains why the approach taken so far to mitigate global climate change has failed. The central reason is an inability to enforce targets and timetables. Current proposals recommending even stricter emission limits will not help unless they are able to address the enforcement deficit. Trade restrictions are one means for doing so, but trade restrictions pose new problems, particularly if they are applied to enforce economy-wide emission limitation agreements. This paper sketches a different approach that unpacks the climate problem, addressing different gases and sectors using different instruments. It also explains how a failure to address the climate problem fundamentally will only create incentives for different kinds of responses, posing different challenges for climate change governance.

Post-2012 climate policy dilemmas: A review of proposals
Onno Kuik, Jeroen Aerts, Frans Berkhout, Frank Biermann, Jos Bruggink, Joyeeta Gupta and Richard S J Tol
Climate Policy (2008) 8(3): 317-336.
This article assesses a wide range of alternative proposals for post-2012 international climate policy regimes. We believe that these proposals will serve as a basis for debates about how to configure post-2012 climate policy. The article characterizes and assesses the policy proposals along the lines of five key policy dilemmas. We argue that (1) many proposals have ideas on how to reduce emissions, but fewer have a solution on how to stimulate technical innovation; (2) many proposals formulate climate policy in isolation, while there are fewer proposals that try to mainstream climate policies in other policy areas; (3) many proposals advocate market-based solutions, while fewer realize that there are certain drawbacks to this solution especially at the international level; (4) most proposals have a preference for a UN-based regime, while a more fragmented regime, based on regional and sectoral arrangements may be emerging; and (5) most proposals have ideas about mitigation, but not many have creative ideas on how to integrate mitigation with adaptation.

A Chinese sky trust?: Distributional impacts of carbon charges and revenue recycling in China
Mark Brenner, Matthew Riddle and James K. Boyce
Energy Policy (2007) 35(3): 1771-1784.
The introduction of carbon charges on the use of fossil fuels in China would have a progressive impact on income distribution. This outcome, which contrasts to the regressive distributional impact found in most studies of carbon charges in industrialized countries, is driven primarily by differences between urban and rural expenditure patterns. If carbon revenues were recycled on an equal per capita basis via a ‘sky trust,’ the progressive impact would be further enhanced: low-income (mainly rural) households would receive more in sky-trust dividends than they pay in carbon charges, and high-income (mainly urban) households would pay more than they receive in dividends. Thus a Chinese sky trust would contribute to both lower fossil fuel consumption and greater income equality.

Distribution of emissions allowances as an opportunity
Stephen J. DeCanio
Climate Policy (2007) 7(2): 91-103.
Much of the debate on climate policy in the USA focuses on the gain or loss to the macroeconomy of alternative policies to reduce greenhouse gas emissions. However, the economy is made up of multiple individuals, not a single representative agent. This article reports the results of alternative ways of distributing emissions allocations across citizens. Macroeconomic effects interact with the policy for distribution, but the distributional weights are more important for the welfare of individual agents than the economy-wide effects of the emissions reductions. Egalitarian distributions of the emissions allowances have the potential to increase the welfare of most people, even if significant emissions reductions are mandated. Focusing on the distribution of emissions allowances (or the revenues generated from an emissions tax) rather than on aggregate GDP may provide guidance in identifying and implementing politically viable solutions to the climate change mitigation problem.

Optimal environmental taxes under relative consumption effects
Richard B. Howarth
Ecological Economics (2006) 58(3): 209-219.
This paper explores the interactions between carbon dioxide emissions taxes and a pre-existing income tax in a numerically calibrated model of climate change and the world economy. Based on evidence from the recent empirical literature, the model allows for the presence of relative consumption effects in the specification of preferences. In the absence of relative consumption effects, optimal emissions taxes would rise from $44 to $229 per tonne of carbon (in year 2000 US dollars) over the course of the next century. These tax rates, which arise when emissions tax revenues are used to reduce taxes on personal income, are slightly above the present value marginal benefits of emissions control. Given realistic assumptions concerning the empirical magnitude of relative consumption effects, the optimal emissions tax rises to $63 per tonne in 2005 and $384 per tonne in 2105. Accounting for relative consumption effects reduces the perceived social benefits of consumption, thus increasing social willingness to pay for environmental quality while reducing both the costs of tax interaction effects and the benefits of efficient revenue recycling. Taken together, these factors support the implementation of comparatively high environmental taxes in the face of relative consumption effects.

An integrated analysis of policies that increase investments in advanced energy-efficient/low-carbon technologies
D.A. Hanson and J. A. Laitner
Energy Economics (2004) 26(4): 739-755.
A new analysis by the EPA Office of Atmospheric Programs and the Argonne National Laboratory (ANL), using the All Modular Industry Growth Assessment (AMIGA) system, indicates that a technology-led investment strategy, can secure substantial domestic reductions of carbon emissions at a net positive impact on the U.S. economy. However, a moderate energy policy, even supported by a carbon charge ranging from US$48 to US$93 per metric ton, is insufficient to reach the so-called Kyoto targets.

Calibration bias in the analysis of environmental taxes
Richard B. Howarth
American Journal of Agricultural Economics (2004) 86: 813-818.
This article explores the role of preexisting taxes in gauging the costs and benefits of taxing CO2 emissions to slow the rate of climate change. In a numerically calibrated model of the world economy that involves a 33% personal income tax, stabilizing emissions at year 2000 levels would yield present-value net benefits of $10.7 trillion. When the model is recalibrated based on the counterfactual assumption of zero taxes and public expenditures, present-value net benefits fall by 87%. This gap arises because the no-tax calibration both overstates people’s true time preference and understates the disutility of increased CO2 levels. Thus, calibration bias adversely affects efforts to gauge the costs and benefits of environmental taxation.