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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…?