Download Aspects of mechanism design in the CDM

FACULTY OF SOCIAL SCIENCES
UNIVERSITY OF COPENHAGEN
Master’s thesis
Anne Sofie Bang Nielsen
Aspects of mechanism design in the CDM
An empirical inquiry into transaction costs and learning-by-doing
Jørgen Birk Mortensen
August 6th 2010
Summary
The regulation of climate change is becoming a pressing issue on the political
scene. Since greenhouse gas (GHG) emissions constitute a vital part of many aspects of modern life, the task to reduce GHG emissions below the scientifically
recommended level carries immense economic costs. A natural requirement for
any mechanism designed to combat climate change is therefore that it is as costefficient as possible. In this respect it is interesting to examine the cost-efficiency
of the Clean Development Mechanism (CDM), one of the three flexible mechanisms under the Kyoto Protocol, created to ensure cost-efficiency in reaching the
reduction targets for the industrialized world. It allows these countries to credit
GHG emission reductions undertaken in the developing world. The CDM was
agreed upon as part of the Kyoto Protocol, signed in December 1997, but in practice, the mechanism was launched in November 2001. The first project, a landfill
gas project in Brazil, was registered in November 2004 and the first Certified
Emission Reductions (CER)s were issued in October 2005. Since then, the CDM
market has grown vividly, UNFCCC (2007). Currently there are 2262 registered
projects in the CDM pipeline, expected to yield a total GHG emission reduction
of 1,828,007 kCERs until 2012.
In this perspective, the CDM has been successful in creating a market for GHG
emissions. The mechanism has however also been heavily criticized for lacking environmental integrity, and for being transaction cost heavy. The critiques
partially concern inherent problems in the mechanism design of the CDM. For
instance, since there is asymmetric information between the regulator and project
developer(s), a range of issues, from inflated baselines, information rents to the
possibility of carbon leakage is caused. To avoid this, a project cycle that strictly
controls the additionality of each project has been developed. This increases
the alternative cost of inflating the GHG emission baseline and thus reduces the
asymmetric information problem. The elaborate project cycle however entails increased transaction costs.
Previous literature including Chadwick (2006), W. Fichtner (2003), Krey (2005),
Woerdman (2001), Michaelowa, Stronzik, Eckermann, and Hunt (2003), and Antinori and Sathaye (2007) have primarily attempted to discuss transaction costs
qualitatively or, if attempting to quantify them, have used only few CDM projects
or extrapolated results from the Activities Implemented Jointly (AIJ) projects,
conducted as a pre-trial phase for Joint Implementation (JI). This shall be seen in
the light that data generally lacks on the characteristics of each CDM project that
would allow for a general evaluation of the transaction costs inferred. The current
study takes a different approach to evaluate the cost-efficiency of the CDM.
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Using quantile regression the elapsed time of the validation and registration step
is investigated, to determine whether the CDM project cycle exhibits a learning
effect. The elapsed time serves as a proxy for the indirect transaction costs of
having an elaborate project cycle, as energy and money directed towards a given
CDM project alternatively could have been used elsewhere. Waiting for a project
validation and registration therefore carries an alternative costs and is a subpart of
the overall transaction costs. The quantile regression reveals that there is a learning effect albeit it is very small. Although the first step, validation by a Designated
Operation Entity (DOE), does exhibit a small learning effect decreasing the median expected validation time of project by 0.31 pct. for each extra project of the
same type that is carried out, this learning effect seems to be crowded out by a
negative learning effect in the registration face, increasing the expected median
registration time by 0.22 pct. for each extra project of the same type registered by
the EB. The overall effect is that the learning effect reduces the median expected
time from a projects is started until it is registered with 0.42 pct. for each additional project of the same type. The estimated effect of learning-by-doing may
represent a lower range for the potential of learning-by-doing in the CDM, since
issues of changing quality of the remaining pool of eligible project may influence
the estimated results. The found learning effect could therefore be a result of two
factors. Either that learning effect is in reality small, since projects differ and
rules change repeatedly, or that there exists an additionality effect, implying that
there will be a lowering of the quality of projects over time, which crowds out the
learning effect. In either instance the found results indicate that the potential of
seeing the elapsed time of the pre-implementation phase of the CDM project cycle
is small, whether it is due to changes in the additionality quality of the remaining
CDM projects or weak potential of learning-by-doing.
The implication of the found results suggest that the literature has generally been
overconfident with regard to the perspectives of achieving a more standardized
and smooth operation of the CDM by increased experience with its project cycle. Held together with other aspects that the mechanism design of the CDM
deals with, such as issues of non-additionality of projects, carbon leakage, dubious incentives for the validating agents as well as possible interference with the
development plans in the developing countries, this indicates a bleak future for
the CDM. It seems difficult to solve all problems with mere fine-tuning of the
current paradigm of the CDM. The study therefore suggest for the international
community to search for other options for a post-2012 agreement. One suggestion, an extension of the current International Emission Trading (IET) scheme to
also include the developing world is given. This mechanism solution suffers less
from problems of asymmetric information and is therefore generally expected to
have lower transaction cost and risk of carbon leakage.
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