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The Economics of Climate Change:
An Economic Critique of Kyoto, and an Alternative Proposal
Dr. Arne Kildegaard
University of Minnesota, Morris
Directions to Morris…
Greenhouse Gases (GHGs) and the atmosphere
CO2 Emissions and Concentrations
CO2 Emissions
CO2 Concentrations and Temperature
Temperature Change
The Industrial Revolution: A Revolution in Energy Usage
Before
After
Revolution in Energy Use (cont’d.)

Exploitation of carbon-based fossil fuels


Consequent CO2 emissions
Deforestation (elimination of carbon sinks)

Consequent elimination of carbon sinks
 Inevitably, higher atmospheric concentrations
Other GHGs

Methane

Nitrous Oxide

Hydroflourocarbons (HFCs)

Perflourocarbons (PFCs)

Sulphur hexaflouride
Consequences: a non-exhaustive list
(from the UNIPCC)

Rising sea levels

Island nations and coastal cities

Freshwater resources (desertification)

Human health


Agriculture



Vector-borne diseases (e.g. malaria)
Cereal production to fall 20% by some GE analyses
Redistribution from tropics to temperate zones
Species and habitat
Can’t we all just get along…?
UN Framework Convention on Climate Control (UNCCC)

Rio Conference

COPs (Council of Parties) Rounds

“Targets and Timetables” (COP1)

Kyoto Protocol (COP3, December, 1997)

Subsequent modifications (COP4-10)

U.S. Repudiation (March, 2001)
Key Features of Kyoto, as Amended

Targets and Timetables


Binding restrictions on “Annex” B countries only


38 countries + EU
Tradeable Discharge Permits (TDP) Scheme


 93% of 1990 emissions by 2008-2012
To minimize total cost of compliance
Treaty Enters into force when countries comprising 55% of Annex B
emissions ratify
Problems with Kyoto

Economic rationality?
$
Marginal Abatement Cost
Marginal Damage Cost
Emissions
E*
Initial
Emissions
Abatement
Problems with Kyoto, cont’d.

Financial Transfers and political sustainability


Wilcoxen & McKibben estimate U.S. permit purchases @ $27-$54 billion
Financial Tranfers and economic instability

Dutch Disease
Problems with Kyoto, cont’d.

Who will monitor compliance?

Governments must bear the domestic economic and political costs of
monitoring, while whatever benefit is shared internationally.
Problems with Kyoto, cont’d.
Which regulatory instrument? It matters…
TDPs vs. “Green Taxes”
$
Marginal Abatement Cost
Emissions
# Permits
Initial
Emissions
Abatement
Problems with Kyoto, cont’d.
Which regulatory instrument? It matters…
TDPs vs. “Green Taxes”
$
Marginal Abatement Cost
Unit emisions tax rate
Emissions
Initial
Emissions
Abatement
TDPs under uncertainty regarding abatement costs
(MAC steeper than MDC)
MAC (actual)
MAC (perceived)
Deadweight
Loss
Permits
Emissions
Green taxes under uncertainty regarding abatement costs
(MAC steeper than MDC)
MAC (actual)
MAC (perceived)
Deadweight
Loss
MDC
Tax rate
Permits
Emissions
Choice of Instruments Under Uncertainty

When MDC “steeper” than MAC
TDPs dominate tax schemes

When MAC “steeper” than MDC
 Taxes dominate TDP schemes
But: “free permits” are politically much more attractive than taxed
emissions
Choice of Instrument: A Hybrid Approach


At the margin, a tax is better
Why not grant permits for the first n units of emissions, and sell permits at
a fixed price thereafter?
Choice of Instruments: A Hybrid Approach
MAC (actual)
MAC (perceived)
Cost of Compliance
MDC
Tax rate
Emissions
Choice of Instruments: A Hybrid Approach
MAC (actual)
MAC (perceived)
Cost of compliance
MDC
Tax rate
Permits granted
Hybrid Approach: Advantages

Appropriate instrument, given uncertainties of cost and relative slopes

Avoids financial transfers between countries

Appropriate incentives to monitor



Tax revenues for government
Firms police each other
Flexible

As more scientific information becomes available, countries can change tax
level appropriately
References


McKibben and Wilcoxen (2002): “The Role of Economics in Climate
Change,” Journal of Economic Perspectives, V.16, No.2, Spring.
United Nations Framework Convention on Climate Change Secretariat
(2003): “Caring for Climate: A Guide to the Climate Change Convention and
the Kyoto Protocol.”
Discussion…?