13.1.2.1 Environmental effectiveness

The main goal of environmental policy instruments and international agreements is to reduce the negative impact of human action on the environment. Policies that achieve specific environmental quality goals better than alternative policies can be said to have a higher degree of environmental effectiveness. It should be noted that although climate protection is the ostensible environmental goal for any climate policy, there may be ancillary environmental benefits (for example, those demonstrated by Burtraw et al. 2001a [NPR] ) for air pollution benefits; see also Section 4.5.2 . for air quality co-benefits).

The environmental effectiveness of any policy is contingent on its design, implementation, participation, stringency and compliance. For example, a policy that seeks to fully address the climate problem while dealing with only some of the GHGs or some of the sectors will be relatively less effective than one that aims at addressing all gases and all sectors.

The environmental effectiveness of an instrument can only be determined by estimating how well it is likely to perform. Harrington et al. 2004 [NPR, MoS] ) distinguish between estimating how effective an environmental instrument will be ex ante and evaluating its performance ex post. These researchers were able to find or recreate ex ante estimates of expected emissions reductions in a series of U.S. and European case studies. Their comparison of the ex ante and ex post observations suggests a reasonable degree of accuracy in the estimates, with those cases in which emissions reductions were greater than expected involving incentive-based instruments, while the cases in which reductions fell short of expectations involved regulatory approaches.

There are situations in which standards are proven to be effective. Regulators may be unduly pessimistic about the environmental performance of incentive-based instruments or unduly optimistic about the performance of regulatory approaches, or perhaps both. Recent evidence suggests that market-based approaches can provide equal if not superior environmental quality improvements over regulatory approaches (see Ellerman, 2006 [NPR] ). As we discuss below, however, institutional constraints may alter the relative efficacy of market- and standards-based instruments.

13.1.2.2 Cost-effectiveness

The cost-effectiveness of a policy is a key decision parameter in a world with scarce resources. Given a particular environmental quality goal, the most cost-effective policy is the one which achieves the desired goal at the least cost. There are many components of cost, and these include both the direct costs of administering and implementing the policy as well as indirect costs, such as how the policy drives cost-reducing technological change.

Cost-effectiveness is distinct from general economic efficiency. Whereas cost-effectiveness takes an environmental goal as given, efficiency involves the process of selecting a specific goal according to economic criteria ( Sterner, 2003 [NPR, MoS] ). Consequently, the choice of a particular environmental goal will likely have dramatic impacts on the overall cost of a policy, even if that policy is implemented using the most cost-effective instrument.

Policies are likely to vary considerably in terms of cost-effectiveness, and any estimation of the costs involved can be challenging ( Michaelowa, 2003b [JoC, SRC] ). While cost-effectiveness estimates traditionally include the direct expenditures incurred as a result of implementing any specific policy, the policy may also impose indirect social costs, which are more difficult to measure ( Davies and Mazurek, 1998 [NPR] ). Moreover, costs for which data are limited are often ignored. Harrington et al. 2000 [MoS] ) provide a summary of commonly excluded costs as well as examples of efforts to estimate these.

Cost-effectiveness can be enhanced with low transaction costs for compliance. This implies limiting the creation of new institutions and keeping implementation procedures as simple as possible while still ensuring system integrity. Studies reported in the literature can be divided into two categories in terms of the economic impacts of the timing of reductions. While some researchers argue that reductions should be postponed until low-cost technologies are available, others argue that necessary decisions have to be made today to avoid a ‘lock-in’ to an emission intensive pathway that would be expensive to leave at a later time point (see also Chapter 11 ).

A common concern is that ex ante cost estimates may not reflect the actual costs of a policy when it is assessed from an ex post perspective. Harrington et al. 2000 [MoS] ) show that the discrepancy between the actual and estimated total costs of 28 environmental regulations in the USA is relatively low and, if anything, that ex ante estimates tend to overstate total costs. While these authors do not systematically evaluate specific environmental instruments, they do find that estimates for market-based instruments tend to overstate unit costs, while unit-costs estimates for other instruments are neither under- nor overestimates.

13.1.2.3 Distributional considerations

Policies rarely apportion environmental benefits and costs evenly across stakeholders. Even if a policy meets an environmental goal at least cost, it may face political opposition if it disproportionately impacts – or benefits – certain groups within a society, across societies or across generations. From an economic perspective, a policy is considered to be beneficial if it improves social welfare overall. However, this criterion does not require that the implementation of that policy actually improves the specific situation of any one individual. Consequently, as ( Keohane et al. 1998 ) ) argue, distributional considerations may be more important than aggregate cost effectiveness when policymakers evaluate an instrument.

The distributional considerations of climate change policies relate largely to equity. Equity can be defined in a number of ways within the climate context (see IPCC, 2001 [NPR] ). Equity and fairness may be perceived differently by different people, depending on the cultural background of the observer. For example, Ringius et al. 2002 [NPR] ) view responsibility, capacity and need as the basic principles of fairness that seem to be sufficiently widely recognized to serve as a normative basis for a climate policy regime. These three principles have been used in the evaluation of potential international climate agreements (e.g. Torvanger et al., 2004 [NPR] ).

A regulation that is perceived as being unfair or for which the incidence is unbalanced may have a difficult time making it through the political process. ^[2] However, distributional considerations are fundamentally subjective, and the most equitable policy may not be the most politically popular one. For example, a policy that focuses the regulatory burden on a low-income subpopulation or country but directs the benefits to a wealthy interest group may sail with ease through the political process. While highly inequitable in costs and benefits, such an instrument is occasionally attractive to politicians. Bulkeley 2001 [JoC] ) describes the different interests in the Australian climate policy debate and suggests that industrial emitters managed to steer the country away from ambitious reduction target – and toward an emissions increase – at the third Conference of the Parties in Kyoto.

Due to the fact that there is little consensus as to what constitutes optimal distribution, it can be difficult to compare – let alone rank – environmental policies based on distributional criteria ( Revesz and Stavins, 2006 [NPR] ). One exception is provided by ( Asheim et al. 2001 ) ), who construct an axiom of equity which, they argue, can be used to evaluate sustainability. ^[3] However, while sustainability may be important when evaluating environmental policies, it only captures the inter-generational dimension of distribution and is imperfectly related to political acceptability.

13.1.2.4 Institutional feasibility

Institutional realities inevitably constrain environmental policy decisions. Environmental policies that are well adapted to existing institutional constraints have a high degree of institutional feasibility. Economists traditionally evaluate instruments for environmental policy under ideal theoretical conditions; however, those conditions are rarely met in practice, and instrument design and implementation must take political realities into account. In reality, policy choices must be both acceptable to a wide range of stakeholders and supported by institutions, notably the legal system. Other important considerations include human capital and infrastructure as well as the dominant culture and traditions. The decision-making style of each nation is therefore a function of its unique political heritage. Box 13.2 provides an example for one country, taken largely from OECD 2005c [NPR] ).

Certain policies may also be popular due to institutional familiarity. Although market-based instruments are becoming more common, they have often met with resistance from environmental groups. Market-based instruments continue to face strong political opposition, even in the developed world, as demonstrated by environmental taxes in the USA or Europe. Regulatory policies that are outside of the norm of society will always be more difficult to put into effect (e.g. speed limits in Germany, or private sector participation in water services in Bolivia).

Another important dimension of institutional feasibility deals with implementing policies once they have been designed and adopted. Even if a policy receives political support, it may be difficult to implement under certain bureaucratic structures.

13.2.1.1 Regulations and standards

Regulatory standards are the most common form of environmental regulation, and they cover a wide variety of approaches. A regulatory standard specifies with a certain degree of precision the action(s) that a firm or individual must undertake to achieve environmental objectives and can consist of such actions as specifying technologies or products to use or not use and/or more general standards of performance as well as proclaiming dictates on acceptable and unacceptable behaviour. Two broad classes of regulatory standards are technology and performance standards. Technology standards mandate specific pollution abatement technologies or production methods, while performance standards mandate specific environmental outcomes per unit of product. In this context, where a technology standard might mandate specific CO₂ capture and storage methods on a power plant, a performance standard would limit emissions to a certain number of grams of CO₂ per kilowatt-hour of electricity generated. A product standard would, for example, be the requirement that refrigerators operate minimally at a specified level of efficiency, while a technology-forcing standard would involve setting the refrigerator efficiency requirement slightly beyond present-day technological feasibility but announcing that the efficiency requirement will not go into effect until a number of years following the announcement.

The primary advantage of a regulatory standard is that it may be tailored to an industry or firm, taking into account the specific circumstances of that industry or firm. There is also a more direct connection between the regulatory requirement and the environmental outcome, which can provide some degree of certainty.

Technology standards involve the regulator stipulating the specific technology or equipment that the polluter must use. Technology standards are best used when there are few options open to the polluter for controlling emissions; in this case, the regulator is able to specify the technological steps that a firm should take to control pollution. The information requirements for technology standards are high: the regulator must have good and reliable information on the abatement costs and options open to each firm. Losses in cost effectiveness arise when regulators are less well informed; technology standards may then be applied uniformly to a variety of firms, rather than tailoring the standard to the actual circumstance of the firm. This raises costs without improving environmental effectiveness and is one of the main drawbacks to regulatory standards.

Performance standards can reduce these potential problems with technology standards by providing more flexibility ( IPCC, 2001 [NPR] ). Costs can generally be lower whenever a firm is given some discretion in how it meets an environmental target. Performance standards expand compliance options beyond a single mandated technology and may include process changes, reduction in output, changes in fuels or other inputs and alternative technologies. Despite this increased flexibility, performance standards also require well-informed and responsive regulators.

One problem with regulatory standards is that they do not provide polluters with the incentive(s) to search for better approaches to reducing pollution. Thus, they may not perform well in inducing innovation and technological change ( Jaffe et al., 2003 [NPR] ; Sterner, 2003 [NPR, MoS] ). If a government mandates a certain technology, there is no economic incentive for firms to develop more effective technologies. Moreover, there may be a ‘regulatory ratchet’ whereby firms are discouraged from developing more effective technologies out of fear that standards will be tightened yet again ( Harrington et al., 2004 [NPR, MoS] ). Finally, although it may be possible to force some technological change through technology mandates, it is difficult for regulators to determine the amount of change that is possible at a reasonable economic cost. This raises the possibility of implementing either costly, overly stringent requirements or, alternatively, weak, unambitious requirements ( Jaffe et al., 2003 [NPR] ). Nevertheless, there are examples in the literature of technology innovations spurred by regulatory standards. For example, Wätzold 2004 [NPR, MoS] ) reported innovative responses from pollution control vendors in Germany in response to standards for SO₂ control.

Although relatively few regulatory standards have been adopted with the sole aim of reducing GHG emissions, standards have been adopted that reduce these gases as a co-benefit. For example, there has been extensive use of standards to increase energy efficiency in over 50 nations ( IPCC, 2001 [NPR] ). Energy efficiency applications include fuel economy standards for automobiles, appliance standards, and building codes. ^[5] These types of policies are discussed in more detail in Chapters 5 and 6 of this report. Standards to reduce methane and other emissions from solid waste landfills have been adopted in Europe, the USA and other countries (see Chapter 10 ) and are often driven by multiple factors, including the reduction of volatile organic compound (VOC) emissions, improved safety by reducing the potential for explosions and reduced odours for local communities ( Hershkowitz, 1998 [NPR] ).

There are a number of documented situations in which regulatory standards have worked well (see Freeman and Kolstad, 2006 [NPR, SRC] ; Sterner, 2003 [NPR, MoS] Sterner 2003 [NPR, MoS] ) reports several cases of such situations, including those in which firms are not responsive to price signals (e.g. in non-competitive settings or with state enterprises) and where monitoring emissions is difficult but tracking the installation of technology is easy. In situations where there is imperfect monitoring and homogeneous abatement costs between firms, ( Montero 2005 ) ) finds that standards may lead to lower emissions and may be economically more efficient than market-based instruments. Based on an analysis of the German SO₂ abatement programme, Wätzold 2004 [NPR, MoS] ) concludes that a technology standard may be acceptable when only one technology exists to achieve an environmental result and, therefore, firms do not face differential abatement costs. Finally, standards may be desirable where there are informational barriers that prevent firms or individuals from responding solely to price signals. This may be particularly relevant for energy efficiency standards for household appliances and other similar applications ( OECD, 2003d [NPR] ). Chapter 6 provides additional information on this subject.

A growing body of literature is focusing on whether regulatory standards or market-based instruments are preferable for developing countries. One common view is that technology standards may be more appropriate for building the initial capacity for emissions reduction because economic incentive programmes require more specific and greater institutional capacity, have more stringent monitoring requirements and may require fully developed market economies to be effective ( IPCC, 2001 [NPR] ; Bell and Russell, 2002 [NPR] Willems and Baumert 2003 [NPR] ) support this approach but also note that technology approaches, policies and measures may have greater applicability to the general capacity needs of developing countries interested in pursuing sustainable development strategies (See Box 13.3 Russell and Vaughan 2003 [NPR] ) suggest that a transitional strategy is the appropriate approach for developing countries, whereby technology standards are introduced first, followed by performance standards and finally by experimentation with market-based instruments. An alternative view is that, in some cases, a performance standard at the facility level and an overall emissions cap could provide a more a more effective structure ( (Ellerman, 2002; ) Kruger et al., 2003 [NPR, SRC] ). This type of approach could also facilitate a transition to a tradable permits programme as the institutions and economies develop over time.

13.2.1.2 Taxes and charges

An emission tax on GHG emissions requires individual emitters to pay a fee, charge or tax ^[6] for every tonne of GHG released into the atmosphere. ^[7] An emitter must pay this per-unit tax or fee regardless of how much emission reduction is being undertaken. ^[8] Each emitter weighs the cost of emissions control against the cost of emitting and paying the tax; the end result is that polluters undertake to implement those emission reductions that are cheaper than paying the tax, but they do not implement those that are more expensive, ( IPCC, 1996 [NPR] , Section 11.5.1; IPCC, 2001 [NPR] , Section 6.2.2.2; Kolstad, 2000 [NPR, SRC] ). Since every emitter faces a uniform tax on emissions per tonne of GHG (if energy, equipment and product markets are perfectly competitive), emitters will undertake the least expensive reductions throughout the economy, thereby equalizing the marginal cost of abatement (a condition for cost-effectiveness). Taxes and charges are commonly levelled on commodities that are closely related to emissions, such as energy or road use.

An emissions tax provides some assurance in terms of the marginal cost of pollution control, but it does not ensure a particular level of emissions. Therefore, it may be necessary to adjust the tax level to meet an internationally agreed emissions commitment (depending on the structure of the international agreement). Over time, an emissions tax needs to be adjusted for changes in external circumstances, such as inflation, technological progress and new emissions sources ( Tietenberg, 2000 [NPR] ). Fixed emissions charges in the transition economies of Eastern Europe, for example, have been significantly eroded by the high inflation of the past decade ( Bluffstone and Larson, 1997 [NPR] ). Innovation and invention generally have the opposite effect by reducing the cost of emissions reductions and increasing the level of reductions implemented. If the tax is intended to achieve a given overall emissions limit, the tax rate will need to be increased to offset the impact of new sources ( Tietenberg, 2000 [NPR] ).

Most environmentally related taxes with implications for GHG emissions in OECD countries are levied on energy products (150 taxes) and on motor vehicles (125 taxes), rather than on CO₂ emission directly. There is also a significant number of waste-related taxes in OECD countries (about 50 taxes in all), levied either on particular products that can cause particular problems for waste management (about 35 taxes) or on various forms of final waste disposal, including those on incineration and/or land-filling (15 taxes in all). A very significant share of all the revenues from environmentally related taxes originates from taxes on motor fuels. Such taxes were introduced in all member countries many decades ago – primarily as a means to raise revenue. Irregardless of the underlying reasoning for their implementation, however, they do impact on the prices (potential) car users are confronted with and thus have important environmental impacts.

However, there is some experience with the direct taxation of CO₂ emissions. The Nordic Council of Ministers ( 2002 ) notes that CO₂ emissions in Denmark decreased by 6% during the period 1988 – 1997 while the economy grew by 20%, but that they also decreased by 5% in a single year – between 1996 and 1997 – when the tax rate was raised. Bruvoll and Larsen 2004 [NPR] ) analysed the specific effect of carbon taxes in Norway. Although total emissions did increase, these researchers found a significant reduction in emissions per unit of GDP over the period due to reduced energy intensity, changes in the energy mix and reduced process emissions. The overall effect of the carbon tax was, however, modest, which may be explained by the extensive tax exemptions and relatively inelastic demand in those sectors in which the tax was actually implemented. Cambridge Econometrics 2005 [NPR, MoS] ) analysed the impacts of the Climate Change Levy in the UK and found that total CO₂ emissions were reduced by 3.1 MtC – or 2.0% – in 2002 and by 3.6 MtC in 2003 compared to the reference case. The reduction is estimated to grow to 3.7 MtC – or 2.3% – in 2010 .

To implement a domestic emissions tax, governments must consider a number of issues, such as the level at which the tax should be set, particularly in the case of pre-existing taxes (e.g. taxes which already exist on energy), or other potential distortions (e.g. subsidies to certain industries or fuels). Consideration must also be given to how the tax is used, with such options as whether it goes directly into general government coffers, is used to offset other taxes (i.e. the double-dividend effect), is transferred across national boundaries to an international body, is earmarked for specific abatement projects, such as renewable energy, or is allocated to those most adversely impacted by either the costs of emission reduction or damage from climate change. Another important issue is the point at which the tax is should be levied. A tax on gasoline may be levied at the pump and collected directly from consumers or it may be levied on wholesale gasoline production and collected from oil companies. In either case, the final consumer ultimately pays most of this cost, but the administrative and monitoring costs may differ dramatically in the two cases.

Emission taxes do well in both cost effectiveness and environmental effectiveness. The real obstacles facing the use of emission taxes and charges are distributional and, in some countries, institutional. At the best of times, new taxes are not politically popular. Furthermore, emissions or energy taxes often fall disproportionately on lower income classes, thereby creating negative distributional consequences. In developing countries, institutions may be insufficiently developed for the collection of emission fees from a wide variety of dispersed sources. In many countries, state enterprises play a significant role; such public or quasi-private entities may not respond adequately to the incentive effects of a tax or charge.

13.2.1.3 Tradable permits

A steadily increasing amount of research is focusing on tradable permits in terms of, among others, efficiency and equity issues associated with the distribution of permits, implications of economy-wide versus sectoral programmes, mechanisms for handling price uncertainties, different forms of targets and compliance and enforcement issues.

Tradable permit systems can be designed to cover either emissions from a few sectors of the economy or those from virtually the entire economy. ^[9] A number of analyses have found that economy-wide approaches are superior to sectoral coverage because they equalize marginal costs across the entire economy. Using a variety of models, Pizer et al. 2006 [MoS, ARC] ) report that in the USA significant cost savings are linked to an economy-wide programme when compared to a sectoral programme coupled with non-market-based policies. ^[10] Researchers have found similar results for the European Union and the EU ETS. ( Babiker et al., 2003 [ARC] ;( Betz et al., 2004; ) ( Klepper and Peterson, 2004; ) Bohringer and Löschel, 2005 [NPR] ).

Not only the coverage of sectors may vary in a tradable permits programme, but also the point of obligation. The responsibility for holding permits may be assigned directly to emitters, such as energy-using industrial facilities (downstream), to producers or processors of fuels (upstream) or to some combination of the two (a ‘hybrid system’). ^[11] The upstream system would require permits to be held at the level of fossil fuel wholesalers and importers ( (Cramton and Kerr, 2002 ) ). ^[12]

There are two basic options for the initial distribution of permits: (1) free distribution of permits to existing polluters or (2) auctions. ( Cramton and Kerr 2002 ) ) describe a number of equity benefits of auctions, including providing a source of revenue that could potentially address inequities brought about by a carbon policy, creating equal opportunity for new entrants and avoiding the potential for “windfall profits” that might accrue to emissions sources if allowances are allocated at no charge. ^[13] (See Box 13.4 for a discussion of this issue).

Goulder et al. 1999 [Ambiguous] ( and Dinan and Rogers 2002 ) ) find that recycling revenues from auctioned allowances can have economy-wide efficiency benefits if they are used to reduce certain types of taxes. ( Dinan and Rogers 2002 ) ( and Parry 2004 ) ) argue that free allocation of tradable permits may be regressive because this type of allowance distribution leads to income transfers towards higher income groups (i.e. shareholders) at the expense of households. In contrast, these authors find that government revenues from auctions may be used to address equity issues through reductions in taxes or other distributions to low-income households. Ahman et al. 2006 [NPR, SRC] ) argue that a gradual transition from free allocation to auctioning might be a politically feasible manner to develop a fairer distribution of allowances.

To date, most emissions trading programmes have distributed emissions allowances almost entirely through free allocations. ^[14] Experience with the US SO₂ programme shows that the no-cost allocation of allowances was critical for gaining political acceptance for the emissions trading concept ( Ellerman, 2005 [NPR] Christiansen and Wettestad 2003 [JoC] ( and Markussen and Svendsen 2005 ) ) discuss how interest group pressures led to a largely free allocation of allowances in the EU ETS. In a broader sense, the rationale for a policy allowing some free allocation of allowances based on historic emissions is based on the desire to compensate incumbent installations that are affected by the regulation ( (Tietenberg, 2003; ) Harrison and Radov, 2002 [NPR] , Ahman et al. 2006 [NPR, SRC] ).

The number of publications exploring the efficiency, equity and competitiveness implications of allowance allocation approaches is continuing to grow. For example, Burtraw et al. 2001b [NPR] and Fischer 2001 [NPR] ) found that periodic updates of allocations on the basis of production are economically inefficient. In an analysis of a potential emissions trading programme in Alberta, Canada, Haites 2003b [JoC, SRC] ) found that this type of periodic updating of allocations based on each source’s output may reduce the decline in production for some sectors that may arise from an emissions cap but that it may also reduce profits and raise overall costs when compared to a fixed allocation. Demailly and Quirion 2006 [NPR] ) find that under certain assumptions, an output-based allocation in the European cement industry would reduce leakage with limited impacts on production. See Chapter 11 , Section 11.7.4 for a more extensive discussion on competitiveness issues.

A final issue associated with the distribution of allowances is whether excessive market power can distort prices. ( Maeda 2003 ) ) examines how the initial distribution of permits affects the potential emergence of firms with market power. Tietenberg 2006 [NPR] ) summarizes research on market power, including studies on whether different auction designs or initial permit allocation can lead to price manipulation by dominant firms. He concludes that in practice, market power ‘typically has not been a problem in emissions trading.’ There has yet to be an overall assessment of market power in the EU ETS.

Several authors have compared the advantages and disadvantages of absolute targets (i.e., mass emissions limits on a sector or economy) to those of intensity targets (i.e. limits on emission per unit of GDP). ^[15] Ellerman and Wing 2003 [NotFound] and Kolstad 2006 [SRC] ) find that intensity targets can reduce the uncertainties associated with the cost of emission reduction under uncertain economic growth levels. Pizer 2005b [JoC, ARC] ) finds that intensity targets may be more appropriate if the short-term objective is to slow, rather than halt, emissions growth, while Ellerman and Wing 2003 [NotFound] ) show that an intensity target may be set so stringently that it can halt or reverse growth. Dudek and Golub 2003 [NPR] ) argue that absolute targets have more certain environmental results and lower transaction costs for emissions trading, thereby creating stronger incentives for technological change. ( Kuik and Mulder 2004 ) ) find that, for the EU, an intensity or relative target would avoid negative effects on competitiveness but would not reduce emissions at the lowest costs. In contrast, an absolute target combined with permit trading leads to efficient emissions reduction, but its overall macroeconomic costs may be significant. Finally, Quirion 2005 [JoC] ) argues that, in the most plausible cases, an emissions tax and an absolute target are superior to an intensity target and that the welfare gaps between the two types of targets are very small. Overall, intensity targets are less effective than absolute targets if the goal is to achieve a certain level of emissions reduction, but they may be more effective at addressing costs when economic growth is uncertain.

Although a tradable permits approach can ensure that a certain quantity of emissions will be reduced, it does not provide any certainty of price. Price uncertainty may be addressed by a ‘price cap’ or ‘safety valve’ mechanism, which guarantees that the government will sell additional permits if the market price of allowances hits a certain price ( Pizer, 2002 [ARC] ; McKibbon and Wilcoxen; 2002 [NPR] ,( Jacoby and Ellerman; 2004 ) ). ^[16] The underlying reasoning is that GHGs become the focus of concern as they accumulate over an extended period in the atmosphere. There may therefore be less concern about short-term increases in CO₂ as long as the overall trajectory of CO₂ emissions is downward over an extended period ( Newell and Pizer, 2003 [ARC] ). While the safety valve mechanism shares some advantages with price-based mechanisms, such as a tax, the former may have the added political advantage of providing emitters with an additional allocation of allowances ( Pizer, 2005a [NPR, MoS, ARC] ). A safety valve mechanism does not provide any certainty that a particular emissions level will be met, and it requires additional administrative complexity to link a domestic programme with a safety valve to a programme without a safety valve or with a different safety valve price.

Experience with trading programmes in the USA has shown significant benefits can be derived from the temporal flexibility provided by banking provisions in cases where the exact timing of emission reductions is not critical to environmental effectiveness ( Ellerman et al., 2000 [NPR] ; Stavins, 2003 [Ambiguous] ). Allowance banking can create a cushion that will prevent price spikes and can hedge uncertainty in allowance prices ( (Jacoby and Ellerman, 2004 ) ). ^[17] A banking provision allows the arbitrage between actual marginal abatement costs in one phase of a programme and the expected abatement costs in a future phase of a programme. The temporal flexibility of banking is particularly useful for companies facing large capital expenditures because it provides some flexibility in the timing of those expenditures ( (Tietenberg, 2003 ) ). In some emission markets in the USA, banking has been restricted where there was concern about short-term increases in emissions ( Tietenberg, 2006 [NPR] ). Banking was also restricted between Phase I and Phase 2 in the EU ETS to avoid a large bank that would make it more difficult to meet Kyoto targets.

Several critical elements of an effective enforcement regime for emissions trading have been described in the literature. First, if the goal is strict adherence to the emission limits implied by the number of permits, then excess emissions penalties should be set at levels substantially higher than the prevailing permit price in order to create the appropriate incentives for compliance ( (Swift, 2001; ) Stranland et al., 2002 [MoS] ). ^[18] A second component of an enforcement regime is reasonably accurate emissions monitoring ( Stranland et al., 2002 [MoS] ; Stavins, 2003 [Ambiguous] ( San Martin 2003 ) ( and Montero 2005 ) ) report that incomplete monitoring can undermine the efficiency of trading programmes. ( Tietenberg 2003 ) and Kruger et al. 2000 [NPR, SRC] ) emphasize that public access to emissions and trading data provides an additional incentive for compliance.

Finally, there have been several experiments with tradable permits for conventional pollution control in developing countries and economies in transition ( Bygrave, 2004 [NPR] ; US EPA, 2004 [NotFound] ). For example, ( Montero et al. 2002 ) ) evaluate an experiment with tradable permits for total suspended particulates (TSP) in Santiago, Chile and find that permit markets are underdeveloped due to high transaction costs, uncertainty and poor enforcement. However, they also find an improved documentation of historic emissions inventories and an increased flexibility to address changing market conditions. S. Gupta 2003b [NPR, MoS, SRC] and Wang et al. 2004 [NPR] ) suggest strengthening the monitoring and enforcement capacity that would be required to implement conventional pollution trading programmes in India and China, respectively. Several authors have concluded that tradable permit programmes may be less appropriate for developing countries due to their lack of appropriate market or enforcement institutions. ( (Blackman and Harrington, 2000, ) Bell and Russell, 2002 [NPR] )

13.2.1.4 Voluntary agreements

Voluntary agreements are agreements between a government authority and one or more private parties to achieve environmental objectives or to improve environmental performance beyond compliance to regulated obligations. Voluntary agreements are playing an increasingly important role in many countries as a means to achieve environmental and social objectives. They tend to be popular with those directly affected and can be used when other instruments face strong political opposition ( Thalmann and Baranzini, 2005 [NPR] ). Box 13.5 provides examples of VAs. See Chapter 7 , Section 7.9.2 for additional information.

Voluntary agreements can take on many forms with varying levels of stringency. While all VAs are ‘voluntary’ insofar as firms are not compelled to join, some may involve incentives (rewards or penalties) for participation. Firms may agree to direct emissions reductions or to indirect reductions through changes in product design (see Chapter 6 , Section 6.8.2.2 .). Agreements may be stand-alone, but they are often used in conjunction with other policy instruments. Voluntary agreements are also a subset of a larger set of ‘voluntary approaches’ in which industry may first negotiate standards of behaviour with other firms or private groups and then allow third parties to monitor compliance. This larger set also includes unilateral voluntary actions by industry. See Section 13.4 , Box 13.5 , and Chapter 7 , Section 7.9.2 for more information on voluntary actions.

The benefits of VAs for individual companies and for society may be significant. Firms may enjoy lower legal costs, enhance their reputation and improve their relationships with society on a whole and shareholders in particular. Societies gain to the extent that firms translate goals into concrete business practices and persuade other firms to follow their example. The negotiations involved to develop VAs raise awareness of climate change issues and potential mitigative actions within industry ( Kågeström et al., 2000 [NPR] ), establish a dialogue between industry and government and help shift industries towards best practices.

Evaluating the effectiveness of VAs is not easy. The standard approach is first to measure the environmental performance of a group of firms participating in a VA and then to compare the performance to that of a typical non-participating firm or firms. One problem with this approach is selection bias: it is often the best-performing firms that enter into a VA. A second and related problem is the counterfactual: it is difficult to know what a firm might have done had they not entered into the VA. Very few studies have attempted to evaluate VAs by taking into account both of these issues. Studies which do not take these factors into account can produce an overly optimistic view of the performance of a VA.

The environmental effectiveness of VAs is the subject of much discussion. Some governments – as well as industry – believe that VAs are effective in reducing GHG emissions ( IAI, 2002 [NPR] ; OECD, 2003c [NPR] Rietbergen et al. 2002 [ARC] ) investigated whether the voluntary agreements in The Netherlands have resulted in improvements in energy efficiency beyond what would have occurred in the absence of such agreements. They estimate that, on average, between 25% and 50% of the energy savings in the Dutch manufacturing industry can be attributed to the policy mix of the agreements and supporting measures.

Others are more sceptical about the efficacy of VAs in reducing emissions. Independent assessments of VAs – while acknowledging that investments in cleaner technologies have resulted in absolute emission improvements – indicate that there is little improvement over business-as-usual (BAU) scenarios, as these investments would have probably happened anyway ( (Harrison, 1999; ) ( King and Lenox, 2000; ) Rietbergen and Blok, 2000 [NPR, ARC] ; OECD, 2003e [NPR] ; Rivera and deLeon, 2004 ). The economic efficiency of VAs can also be low, as they seldom incorporate mechanisms to equalize marginal abatement costs between different emitters ( Braathen, 2005 [NPR] ).

There are a limited, although increasing, number of comprehensive reviews of the effectiveness of VAs, but any comparison of these reviews and assessments is difficult because of the different metrics and evaluative criteria employed ( Price, 2005 [NPR, ARC] ). In general, studies of the design and efficacy of VAs assess only a single programme (e.g. ( Arora and Cason, 1996; ) ( Khanna and Damon, 1999; ) ( King and Lenox, 2000; ) ( Welch et al., 2000; ) ( Rivera, 2002; ) Croci, 2005 [NPR] ). Based on her evaluation of the French experience, ( Chidiak 2002 ) ) suggests that the reductions in GHG emissions cannot necessarily be seen as a direct consequence of the commitments within the agreements and argues that, in actual fact, these improvements have been triggered largely as a result of other environmental regulations and cost reduction efforts. ( Johannsen 2002 ) ( and Helby 2002 ) ) present similar results for programmes in Denmark and Sweden, respectively. They note that reductions in specific emissions correspond with industry’s BAU behaviour, thereby suggesting that the stated objectives in the agreements were not sufficiently ambitious. In particular, Helby concludes that EKO-Energi, which sought to highlight a new level of best practice and thus pose a challenge to other firms, was ‘at best a very modest success,’ resulting in a small overall direct effect on total industrial energy consumption. Interestingly, Chidiak also finds that the agreements did not foster intra-industry networking and information exchange on energy management and suggests that their failure to achieve more ambitious goals is a result of the lack of a well-articulated policy-mix. Other analyses indicate that VAs work best as part of a policy package, rather than as a stand-alone instrument ( Krarup and Ramesohl, 2002 [NPR, MoS] ; Torvanger and Skodvin, 2002 [NotFound] OECD 2003e [NPR] and Braathen 2005 [NPR] ) note that many of the current VAs would perform better if there were a real threat of other instruments being used if targets are not met.

The US Government Accountability Office ( 2006 ), in its review of the US Climate Vision and Leaders Programmes, which are supported by the Environmental Protection Agency (EPA) and Department of Energy (DOE), finds that emission reduction goals were set for only 38 of 74 participants, that some goals are intensity-based and others emission-based and that programmes vary in terms of how they are measured, the time periods covered, the requirements for reporting and the means of tracking progress. Brouhle et al. 2005 [NPR] ) note that the difficulties in evaluating US programmes is associated to the many different programmes and their goals that need be sorted, the availability of adequate data and the measuring of achievement relative to a baseline. Jaccard et al. 2006 [NPR] ) review various Canadian voluntary programmes that have been in existence for 15 years and report that during that period emissions have grown by 25%.

Darnall and Carmin 2003 [NPR] ) review 61 governmental, industry and third-party general environmental agreements, mainly in the USA (see also Lyon and Maxwell, 2000 [NPR] ). Overall, their results demonstrate that the voluntary programmes had low programme rigour in that they had limited levels of administrative, environmental and performance requirements. For example, two thirds did not require participants to create environmental targets and to demonstrate that the targets were met. Similarly, almost 50% of the programmes had no monitoring requirements. Compared to government programmes, industry programmes had stronger administrative requirements and third party programmes had yet even slightly stronger requirements. According to ( Hanks 2002 ) and OECD 2003e [NPR] ), the best VAs include: a clear goal and baseline scenario; third party participation in the design of the agreement; a description of the parties and their obligations; a defined relationship within the legal and regulatory framework; formal provisions for monitoring, reporting and independent verification of results at the plant level; a clear statement of the responsibilities expected to be self-financed by industry; commitments in terms of individual companies, rather than as sectoral commitments; references to sanctions or incentives in the case of non-compliance.

It must be acknowledged that VAs fit into the cultural traditions of some countries better than others. Japan, for example, has a history of co-operation between government and industry that facilitates the operation of “voluntary” programmes. Some examples of VAs in various countries are provided in Box 13.5 .

13.2.1.5 Subsidies and incentives

Direct and indirect subsidies can be important environmental policy instruments, but they have strong market implications and may increase or decrease emissions, depending on their nature. Subsidies aimed at reducing emissions can take different forms, ranging from support for Research and Development (R&D), investment tax credit, and price supports (such as feed-in tariffs for renewable electricity). ^[21] Subsidies that increase emissions typically involve support for fossil fuel production and consumption. They tend to expand the subsidized industry, relative to the non-subsidy case. If the subsidized industry is a source of GHG emissions, subsidies may result in higher emissions. Subsidies to the fossil fuel sector result in over-use of these fuels with resulting higher emissions; subsidies to agriculture can result in the expansion of agriculture into marginal lands and corresponding increases in emissions. Conversely, incentives to encourage the diffusion of new technologies, such as those for renewables or nuclear power, may promote emissions reductions.

One of the significant advantages of subsidies is that they have politically positive distributional consequences. The costs of subsidies are often spread broadly through an economy, whereas the benefits are more concentrated. This means that subsidies may be easier to implement politically than many other forms of regulatory instruments. Subsidies do tend to take on a life of their own, which makes it difficult to eliminate or reduce them, should that be desired.

The International Energy Agency (IEA) estimates that in 2001 energy subsidies in OECD countries alone were approximately 20–80 billion US$ ( IEA, 2001 [NPR] ). The level of subsidies in developing and transition economy countries is generally considered to be much higher. One example is low domestic energy prices that are intended to benefit the poor, but which often benefit high users of energy. The result is increased consumption and delayed investments in energy-efficient technologies. In India, kerosene and liquefied petroleum gas (LPG) subsidies are generally intended to shift consumption from biomass to modern fuels, reduce deforestation and improve indoor air quality, particularly in poor rural areas. In reality, these subsidies are largely used by higher expenditure groups in urban areas, thus having little effect on the use of biomass. Nevertheless, removal of subsidies would need to be done cautiously, in the absence of substitutes, as some rural households use kerosene for lighting ( (Gangopadhyay et al., 2005 ) ).

OECD countries are slowly reducing their subsidies to energy production or fuel (such as coal) or changing the structure of their support to reduce the negative effects on trade, the economy and the environment. Coal subsidies in OECD countries fell by 55% between 1991 and 2000 ( IEA, 2001 [NPR] ). ^[22] (See Chapter 7 for additional information.) ^[23] About 460 billion US$ is spent on agricultural subsidies, excluding water and fisheries ( Humphreys et al., 2003 [NPR] ), with OECD countries accounting for about 318 billion US$ or 1.2% of the GDP. These subsidies result in the expansion of this sector with associated GHG implications ( OECD, 2001 [NPR] , 2002 ).

Many countries provide financial incentives, such as tax credits for energy-efficient equipment and price supports for renewable energy, to stimulate the diffusion of technologies. In the USA, for example, the Energy Policy Act of 2005 contains an array of financial incentives for various advanced technologies; these financial incentives have been estimated at 11.4 billion US$ over a 10-year period.

One of the most effective incentives for fostering GHG reductions are the price supports associated with the production of renewable electricity, which tend to be set at attractive levels. These price supports have resulted in the significant expansion of the renewable energy sector in OECD countries due to the requirement that electric power producers purchase such electricity at favourable prices. The US Public Utility Regulatory Policy Act of 1978 requires electric utilities to buy renewable energy at “avoided cost”. In Europe, specific prices have been set at which utilities must purchase renewable electricity – these are referred to as ‘feed-in tariffs’. These tariffs have been effective at promoting the development of renewable sources of electricity ( (Ackermann et al., 2001; ) ( Menanteau et al., 2003 ) ). As long as renewables remain a relatively small portion of overall electricity production, consumers see only a small increase in their electricity rates. Incentives therefore have attractive properties in terms of environmental effectiveness, distributional implications and institutional feasibility. The main problem with them is cost-effectiveness: They are costly instruments, particularly in the long-run as interests and industries grow to expect the continuation of subsidy programmes. See Chapter 4.5 for a more extensive discussion.

13.2.1.6 Research and Development ^[24]

The role of R&D in changing the trajectory of energy economy is unquestionable – new technologies have played a large role in the evolution of the energy sector over the last century. Moreover, the rate at which low emission technologies will improve during the next 20–30 years will be an important determinant of whether low emission paths can be achieved in the long term.

Policy uncertainties, however, often hinder investment in R&D and the dissemination of new technology, although different types of polices may be needed to address different types of investment. Hamilton 2005 [NPR] ) notes that investors prefer a policy environment which is ‘loud, long and legal’. A number of authors note that long-term policy targets or clear foresight on carbon taxes can overcome social inertia and reduce uncertainty for investors in R&D ( Blyth and Yang, 2006 [NPR] ; Edenhofer et al., 2006; Reedman [ARC] Graham and Coombes, 2006 [MoS] ).

Nearly 600 billion US$ was expended worldwide on R&D in all sectors in 2000, with approximately 85% of that amount being spent in only seven countries. ^[25] Over the last 20 years, the percentage of government-funded R&D has generally declined, while industry-funded R&D has increased in these countries. In a historic context, R&D expenditures as a percentage of GDP have gone up and down in cycles as government priorities have changed over the last 50 years, although in some instances comparisons over time are difficult (US-NSF, 2003; OECD, 2005a [NPR] ; US-GAO, 2005 ).

Total public funding for energy technologies in IEA countries during the period 1987 – 2002 was 291 billion US$, with 50% of this allocated to nuclear fission and fusion, 12.3% to fossil fuels and 7.7% to renewable energy technologies ( IEA, 2004 [NPR] ; see Figure 13.1 ). ^[26] Funding has dropped after the initial interest created through the oil shock in the 1970 s and has stayed constant, even after the UNFCCC was ratified. Nemet and Kammen 2006 [NPR] ) suggest that for the USA a change in direction is warranted and that a five- to tenfold increase in public funding is feasible.

Figure 13.1: Public funded Research and Development (R&D) expenditures for energy (A) and renewable energy technologies (B) by International Energy Agency (IEA) member countries.

Source: IEA, 2004 [NPR] , 2005 .

The USA and Japan, the two largest investors in energy R&D, spent on average of 3.38 and 2.45 billion US$, respectively, between 1975 and 1999 . However, such figures mask important underlying trends. For example, a large percentage of the funding designated for energy R&D has gone into nuclear power – nearly 75% in the case of Japan ( Sagar and van der Zwaan 2006 [NPR] ). The support of the US government for R&D declined by 1 billion US$ from 1994 to 2003, with reductions implemented in nearly all energy technologies, while R&D investments in other areas grew by 6% per year. Between the 1980 s and 2003, private sector energy R&D declined from nearly 50% of that of government funding to about 25% ( Nemet and Kammen, 2006 [NPR] ).

Many countries pursue technological (R&D) advancements as a national policy for a variety of different reasons: for example, to foster the development of innovative technologies or to assist domestic industries in being competitive. Countries also chose to co-operate with each other in order to share costs, spread risks, avoid duplication, access facilities, enhance domestic capabilities, support specific economic and political objectives, harmonize standards, accelerate market learning and create goodwill. Cooperation, however, may increase transaction costs, require extensive coordination, raise concerns over intellectual property rights and foreclose other technology pathways ( (Fritsche and Lukas, 2001; ) ( Sakakibara, 2001; ) ( Ekboir, 2003; ) Justice and Philibert, 2005 [NPR] ). Governments use a number of tools to support R&D, such as grants, contracts, tax credits and allowances and public/private partnerships. The effect of these tools on public budgets and their effectiveness in stimulating innovation will vary as a function of how they are structured and targeted. For example, in the USA, R&D tax credits to industry totalled an estimated 6.4 billion US$ in 2001; however, industries associated with high GHG emissions did not take advantage of this opportunity in that the utility industry received only 23 million US$. ^[27]

There are different views on the role of R&D, its links to the overall energy innovation system and processes underlying effective learning. Sagar and van der Zwaan 2006 [NPR] ) examined the trends in major industrialized countries and report that public R&D spending does not correlate with changes in national energy intensity or carbon emissions per unit of energy consumption. For a more extensive discussion of technological learning, energy supply models and the link to R&D, see Chapter 3 , Section 3.4.2 and Chapter 11 , Section 11.3.3 ( Watanabe 1999 ) ) argues that government R&D can play a role in achieving breakthroughs in some areas, induce investments by industry in R&D and generate trans-sectoral spill over effects. Others have noted, however, that the benefits of R&D may not be realized for two to three decades, which is beyond the planning horizons of even the most forward-looking companies ( Anderson and Bird, 1992 [MoS] ) and that, for a variety of reasons, industry can only appropriate a fraction of the benefits of R&D investments ( (Margolis and Kammen 1999 ) ). In the energy sector in particular, technology ‘spill over’ to competitors is large; as a result, firms under-invest in R&D ( (Azar and Dowlatabadi 1999 ) ) and face difficulties in evaluating intangible R&D outputs ( Alic et al. 2003 [NPR] ). ^[28] In addition, regulatory interventions can cap profits in the case of path-breaking research success ( Foxon and Kemp, 2004 [NPR] ; Grubb, 2004 [ARC] ). ^[29] Goulder and Schneider 1999 [PoC, JoC] ) argue that increasing R&D expenditures in carbon-free technologies could crowd out R&D in the rest of the economy and therefore reduce overall growth rates. However, ( Azar and Dowlatabadi 1999 ) ) counter that radical technological change will trigger more research overall and therefore increase economy-wide productivity rates.

The OECD 2005b [NPR] ) finds that obligations/quotas, price guarantees and tax preferences have had the most influence on innovation and patent activities in the renewable energy sector and that while public subsidies for R&D have not played a role, the overall level of investment in R&D within the economy of a country has been important. Sathaye et al. 2005 [NPR, ARC] ) observe that government-funded research at government-owned facilities, private companies and universities may help identify patentable technologies and processes. They reviewed the process of allocating patent rights in four OECD countries and found that intellectual property rights (IPR) regimes have changed since the ratification of the UNFCCC, with diffusion typically taking place along a pathway of licensing or royalty payments rather than unrestricted use in the public domain. Popp 2002 [NPR, ARC] ) also examined patent citations and found that the level of energy-saving R&D depends not only on energy prices, but also on the quality of the accumulated knowledge available to inventors. He finds evidence for diminishing returns to research inputs – both across time and within a given year – and notes that government patents filed in or after 1981 are more likely to be cited. Popp 2004 [NPR, ARC] ) notes that when in terms of the potential for technology to help solve the climate problem, two market failures lead to underinvestment in climate-friendly R&D: environmental externalities and the public goods nature of the new knowledge. As a result, government subsidies to climate-friendly R&D projects are often proposed as part of a policy solution.

Policies that directly affect the environmental externality have a much larger impact on both atmospheric temperature and economic welfare. Fischer and Newell 2004 [NPR] ) examine several policy options to promote renewables and indicate that research subsidies are the most expensive approach to achieve emission reductions – in the absence of higher prices. They note that the process of technological change is less important than the implementation of direct incentives to reduce emission intensity or overall energy use. A more specific example arises from the Danish experience with wind technologies. Meyer 2004 [NPR] ) notes that despite significant support for wind energy R&D during the 1980 s, wind power only boomed in Denmark when favourable feed-in tariffs were introduced, procedures for construction allowances were simplified and priority was given for green electricity. This is supported by Nemet 2005 [NPR] ), who found that the ability to raise capital and take risks has played a much larger role in the recent expansion of the photovoltaic industry than other factors, such as learning by experience.

In summary, national programmes and international cooperation relating to R&D are essential long-term measures to stimulate technological advances. Substantial additional investments in and policies for R&D are needed, depending on the specific goals: for example, if high stabilization levels are desired (e.g. 750 ppmv CO₂-eq, which is scenario category D of Chapter 3 of this report), a technology-focused approach that defers emissions reduction to the future would be sufficient; for low stabilization goals (e.g. 450 ppmv CO₂-eq, which is category A1, or 550 ppmv CO₂-eq, which is category B), strong incentives for short-term emission reductions would be necessary in addition to technological development and deployment programmes. See Section 13.3 for a discussion of goals.

13.2.1.7 Information instruments

Information instruments – such as public disclosure requirements and awareness/education campaigns – may positively affect environmental quality by allowing consumers to make better-informed choices. When firms or consumers lack the necessary information about the environmental consequences of their actions, they may act inefficiently. While some research indicates an information provision can be an effective environmental policy instrument, we know less about its efficacy in the context of climate change. Examples of information instruments include labelling programmes for consumer products, information disclosure programmes for firms and public awareness campaigns.

Article 6 of the UNFCCC on Education, Training and Public Awareness calls on governments to promote the development and implementation of educational and public awareness programmes, promote public access to information and public participation and promote the training of scientific, technical and managerial personnel. With decision 11/CP.8, the Conference of the Parties (COP) launched a 5-year country-driven work programme to engage stakeholders in information/education activities. The UNFCCC secretariat notes that there is a general lack of resources, limited technical skill and poor regional coordination relating to information and education campaigns ( UNFCCC 2006a [NPR] ).

Information instruments can often be used to improve the effectiveness of other instruments. Another feature common to all information instruments that makes them unique from other environmental policies is that they do not impose penalties for environmentally harmful behaviour per se. A disclosure programme, such as the Toxics Release Inventory (TRI), requires only that firms document and report their emissions; it does not place limits on how much pollution they can emit.

( Kennedy et al. 1994 ) ) demonstrate that environmental externalities can be at least partially corrected through information provision. However, they also point out that when other corrective instruments, such as taxes, are available, these measures are preferable to information policies. Based on a recent theoretical study, ( Petrtakis et al. 2005 ) ) reports that information provision can be more effective than tax instruments, especially when the information can be provided at low cost. ( Osgood 2002 ) ) provides limited empirical support in the context of weather information programmes in Mexico and California.

Evidence-to-date suggests that while disclosure mandates may be effective at changing a firm’s environmental practices, other information instruments, such as advisory programmes, have less effect on consumer behaviour ( (Konar and Cohen, 1997 ) ). Firms whose stock price declined significantly when pollution data became publicly available reduced their emissions more than other firms in the same industry. Firms may view information policies as overly burdensome and argue that voluntarily provided information is sufficient ( Sterner, 2003 [NPR, MoS] ). Certainly, there is a cost to disclosure and labelling policies, and costs depend on the level of information required by a policy ( Beierle, 2004 [NPR] ). A firm may have to collect and disseminate information they would not otherwise have gathered, and government agencies must be able to verify that the information is accurate.

13.2.1.8 Non-climate policies

There are a number of non-climate national policies that can have an important influence on GHG emissions. These include policies focused on poverty, land use and land use change, energy supply and security; international trade, air pollution, structural reforms and population policies. Only a few types of ‘non-climate policies’ are touched upon in this section.

The literature available on this topic indicates that poverty reduces the resilience of vulnerable populations and makes them more at risk to the potential impacts of climate change, but it also leads communities to take measures that may increase emissions. Heemst and Bayangos 2004 [NPR] ) note that if poverty can be reduced without raising emissions, then a strategy to reduce poverty can be seen as a way to reduce emissions as well as enhance resilience. Typical areas of synergy include small-scale renewables ( Richards, 2003 [NPR] ) and community forestry ( Smith and Scherr, 2002 [NPR] ), both of which may benefit the poor.

Land use policies (or the lack thereof), whether terrestrial (agriculture, forestry, nature), aquatic (wetlands) or urban, can lead to enhanced emissions. Verhagen et al. 2004 [NPR, ARC] ) note that policies aimed at integrating climate change concerns with the specific concerns of local people may yield major synergies. For example, within the Netherlands, a major programme is currently underway to understand how spatial planning and climate change policy can be effectively linked. Regional (acid rain abatement), local and indoor air pollution policies can also have climate change co-benefits ( Bakker et al., 2004 [NPR] ).

The consumption of natural resources varies significantly between developed and developing countries and is ultimately one of the major drivers of global emissions. The global population and income levels affect the consumption of natural resources, particularly those of energy, food and fibre, and hence can also affect GHG emissions. Policies that increase consumption of natural resources have implications for GHG emissions.

13.2.2.1 National policy interactions/linkages and packages

Single instruments are unlikely to be sufficient for climate change mitigation, and it is more likely that a portfolio of policies will be required (see IPCC, 2001 [NPR] ). Examples of areas where there are potential synergies include water management strategies, farm practices, forest management strategies and residential building standards. Instruments that maximize potential synergies could become socially and economically efficient and may offer opportunities for countries to achieve sustainable development targets, even in the face of uncertainties. This is especially important given the limited financial and human resources in developing countries ( Dang et al., 2003 [JoC, SRC] ). Climate change considerations also provide both developing and developed countries with an opportunity to look closely at their respective development strategies from a new perspective. Fulfilling development goals through policy reforms in such areas as energy efficiency, renewable energy, sustainable land use and/or agriculture will often also generate benefits related to climate change objectives.

A key synergy is that between adaptation and mitigation policies. Climate policy options can include both mitigation and adaptation (see Chapter 17 of IPCC 2007b [NPR, 2007] ) for a discussion on adaptation policies and Chapter 18 for a detailed analysis of interaction between mitigation and adaptation). Many adaptation options are consistent with pathways towards effective and long-term mitigation and, in turn, several mitigation options can facilitate planned adaptation.

In theory, a perfectly functioning market would need only one instrument (e.g. a tax) to address a single environmental problem, such as climate change. In such a situation, the application of two or more overlapping instruments could diminish economic efficiency while increasing administrative costs. In practice, however, there are market failures that may make a mix of instruments desirable. This section describes some of these cases and addresses situations in which multiple or overlapping objectives might justify a mix of policies.

Climate-related policies are seldom applied in complete isolation: in a large number of cases one or more instruments will be applied. The mere existence of an instrument mix, however, is clearly not ‘proof’ of its environmental effectiveness and economic efficiency. A rather obvious first requirement for applying an environmentally and economically effective instrument mix is to have a good understanding of the environmental issue to be addressed. In practice, many environmental issues can be complex. While a tax can affect the total demand for a product and the choice between different product varieties, it is less suited to address, for example, how a given product is used and when it is used. Hence, other instruments could be needed. A second requirement for designing efficient and effective policies is to have a good understanding of the links with other policy areas: not only do different environmental policies need to be co-ordinated, but co-ordination with other related policies is also necessary. A third requirement is to have a good understanding of the interactions between the different instruments in the mix.

Several authors describe situations in which a combination of policies might be desirable. Johnstone 2002 [NPR] ) argues that the price signal from a tradable permits or tax system may not be sufficient to overcome barriers to technological development and diffusion and that additional policies may be warranted. These barriers include: (1) credit market failures that discourage lenders from providing capital to firms for high-risk investments associated with R&D and even the implementation of new technologies and (2) reduced incentives for private investment in R&D if firms can not prevent other firms from benefiting from their investments (i.e. ‘spill-over’ effects). ^[30] Fischer and Newell 2004 [NPR] ) find that the combination of a technology policy, such as government sponsored R&D, with a tax or tradable permit instrument could help overcome this type of market imperfection.

A second market failure that may require more than one instrument is the lack of information among consumers on the environmental or economic attributes of a technology. In such a case, a price signal alone may not sufficiently spur the diffusion of these types of technologies. One solution to this type of barrier is an eco-labelling system, which can help increase the effectiveness of a price instrument by providing better information on relevant characteristics of the product ( OECD, 2003b [NPR] ; Braathen, 2005 [NPR] Sijm 2005 [JoC] ) notes that this type of market failure may exist for households who may lack the relevant information to invest in energy efficiency measures and may not respond to a price signal. Another market failure in the residential sector may be caused by split incentives where neither the landlord nor tenant has an incentive to invest in energy efficiency measures ( (Sorrell and Sijm, 2003 ) ).

With the implementation of the EU ETS, particular attention has been given to the interaction between a tradable permits mechanism and other policies. Sijm 2005 [JoC] ( and Sorrell and Sijm 2003 ) ) argue that an emissions trading scheme can co-exist with other instruments as long as these other instruments improve the efficiency of the trading mechanism by addressing market failures or contributing to some other policy objective. However, they argue that the combination of an emissions trading scheme with other instruments could also lead to “double regulation”, reduced efficiency and increased costs if policies are not designed carefully. NERA 2005 [NPR] ( and Morthorst 2001 ) ) assess the interaction of renewable energy policies with tradable permits programmes and conclude that if not designed properly, these policies can lower allowance prices but raise the overall costs of the programme.

There may be cases where a package of CO₂ mitigation policies is justified if these policies serve multiple policy objectives. Sijm 2005 [JoC] ) gives several examples of policies and objectives that may be compatible with the EU ETS, including direct regulation that also reduces local environmental effects from other pollutants. Renewable energy policies can be used to expand energy supply, increase rural income and reduce conventional pollutants. Policies that encourage bio-fuel production and automobile fuel efficiency have also been advocated for their advantages in encouraging energy security and fuel diversity as well as GHG mitigation. In the USA, these types of energy policies have been proposed in conjunction with a tradable permits system as part of a package to address energy, security and environmental objectives (NCEP, 2004 ).

13.2.2.2 Criteria assessment

Any evaluation of the instruments based on the criteria discussed herein is challenging for two reasons. First, practitioners must be able to compare potential instruments based on each of the evaluative criteria. Unfortunately, in many cases it can be difficult if not impossible to rank instruments in an objective manner. For example, ( Fischer et al. 2003 ) ) conclude that it is not possible to rank environmental policy instruments based on their technology-stimulating effects. Consequently, it will be difficult to determine which of the available instruments is the most cost-effective. Distributional considerations are also particularly difficult to evaluate. Revesz and Stavins 2006 [NPR] ) provide a discussion of the difficulties involved in evaluating instruments based on distribution or equity. They also cite a number of authors that propose different approaches to evaluating policies.

Nevertheless, it is possible to make general statements about each instrument according to the criteria we have selected. For example, it is generally believed that market-based instruments will be more cost effective than regulations and standards ( (Wiener, 1999 ) ). However, this belief implicitly assumes that a country has well-functioning institutions, the lack of which can result in a market-based instrument being more costly to implement ( (Blackman and Harrington, 2000 ) ). Table 13.1 summarizes the seven instruments presented in this chapter for each of the four criteria we discuss. Sterner 2003 [NPR, MoS] and Harrington et al. 2004 [NPR, MoS] ) provide similar summaries for other instruments.

Second, policymakers must determine how much weight to assign each of the evaluative criteria. Consider two instruments that are equally environmentally effective and both institutionally feasible, but one has unfavourable distributional implications while the other is less cost-effective. In order to choose one instrument over the other, one must assess the relative importance of distribution versus cost-effectiveness. However, the determination of just what weight should be given to each evaluative criterium is a subjective question and one left to policymakers to decide. Some authors do provide some guidelines on how policymakers can determine which evaluative criteria are the most important. Sterner 2003 [NPR, MoS] ) argues that distributional considerations will likely be less important in an economy with relatively less inequality than in countries with large income disparities and also provides additional guidance on other criteria, including institutional flexibility and incentive compatibility. Bell 2003 [NPR] and Bell and Russell 2002 [NPR] ) argue that institutional feasibility is of critical importance in developing countries, where environmental effectiveness and cost-effectiveness may be determined in large part by a government’s institutional capacity. In general, the criteria that receive the most weight will be those that are assessed to be the most important in terms of each country’s specific circumstances.

13.3.3.1 Goals

Most agreements (including those on climate change such as the UNFCCC and the Kyoto Protocol), include specific goals to guide the selection of actions and timing as well as the selection of institutions. Goals can provide a common vision about both the near-term direction and the longer term certainty that is called for by business. In this discussion, goals are distinguished from targets: the former are long-term and systemic, while the latter relate to actions that are near-term and specific. Targets are described under the ‘Targets’ section (13.3.3.4.1) below.

The choice of the long-term ambition level significantly influences the necessary short-term action and, therefore, the design of the international regime. For example, if the goal is set at high stabilization levels (e.g. stabilizing concentrations at 750 ppmv CO₂-eq, scenario category D of Chapter 3 of this report), a technology-focused approach that defers emissions reduction to the future would be sufficient for the time being. For low stabilization goals (e.g. 450 ppmv CO₂-eq, category A1, or 550 ppmv CO₂-eq, category B), short-term emission reductions would be necessary in addition to technological development programmes.

International regimes can incorporate goals for the short and medium term and for the stabilization of GHG concentrations. One option is to set a goal for long-term GHG concentrations or a maximal temperature rise (such as the 2°C goal proposed by the EU). Such levels might be set based on an agreement of impacts to be avoided (see den Elzen and Meinshausen, 2005 [NPR, SRC] ) or on the basis of a cost-benefit analysis (see Nordhaus, 2001 [NPR] ). A number of authors have commented on the advantages and disadvantages of setting long-term goals. Pershing and Tudela 2003 [NPR, SRC] ) suggest that it may be difficult to gain a global agreement on any ‘dangerous’ level due to political and technical difficulties. Conversely, Corfee-Morlot and Höhne 2003 [JoC, SRC] ) believe such goal-setting is desirable as it helps structure commitments and institutions, provides an incentive to stimulate action and helps establish criteria against which to measure the success of implementing measures.

An alternative to agreeing on specific CO₂ concentration or temperature levels is an agreement on specific long-term actions (such as a technology-oriented target, such as ‘eliminating carbon emissions from the energy sector by 2060 ’). An advantage of such a goal is that it might be linked to specific actions. While links between such actions, GHG concentrations and climate impacts can be made, there are uncertainties in the precise correlation between them. Additionally, several different targets would have to be set to cover all climate-relevant activities ( Schelling, 1997 [NPR] ; Pershing and Tudela, 2003 [NPR, SRC] ).

Another option would be to adopt a ‘hedging strategy’ ( IPCC, 2001 [NPR] , chapter 10), which is defined as a shorter term goal on global emissions, from which it is still possible to reach a range of desirable long-term goals. One example of such a strategy is the California goal of reducing emissions to 1990 levels by 2020, and then reducing them to 80% below 1990 levels by 2050 . Once the short-term goal is reached, decisions on subsequent steps can be made in light of new knowledge and decreased levels of uncertainty. To implement this option, the international community could agree on a maximum quantity of permissible GHG emissions in, for example, 2020 ( Corfee-Morlot and Höhne, 2003 [JoC, SRC] ; Pershing and Tudela, 2003 [NPR, SRC] ; Yohe et al., 2004 [JoC, MoS] ).

Another proposal would be to aim at formulating reductions step by step, based on the willingness of countries to act, without explicitly considering a long-term perspective. While such an approach does meet political acceptability criteria, it poses the risk that the individual reductions may not add up to the level required for certain stabilization levels. Some stabilization options may then be out of reach in the near future (see Chapter 3.3, Figure 3.19 ).

13.3.3.2 Participation

The participation of states in international agreements can vary. At one extreme, participation can be universal; at the other extreme, participation can be limited to just two countries. Many studies propose that participation can be differentiated in different tiers (see Staged systems in Table 13.2 ). States participating in the same tier would have the same type of commitments (i.e. in the UNFCCC regime). The most important tiers are Annex I and non-Annex I, but there are also special arrangements for economies in transition as well as for least developed countries. Figure 13.2 shows the groupings of countries under the UNFCCC, OECD and EU. The allocation of states into tiers can be made according to quantitative or qualitative criteria or ‘ad hoc’ (see Table 13.2 ). According to the principle of sovereignty, states may also choose the tier in which they want to be grouped, provided their choice is accepted by other countries (see Kameyama, 2003 [NPR] ;( Reinstein, 2004 ) ).

Figure 13.2: Current country groupings under the UNFCCC, OECD and EU.

Source: Höhne et al. 2005 [Ambiguous] ).

Participation in the agreement can be static, ^[32] or it may change dynamically over time. In the latter case, states can “graduate” from one tier of commitments to the next. Graduation can be linked to the meeting of quantitative thresholds for certain parameters (or combinations of parameters) that have been predefined in the agreement, such as emissions, cumulative emissions, GDP per capita, relative contribution to temperature increase or other measures of development, such as the human development index (see Berk and den Elzen 2001 [JoC, MoS, SRC] Gupta 1998 [NPR, SRC] , 2003a and Höhne et al. 2003 [NPR, SRC] ) for a review of per-capita emissions thresholds; Criqui et al. 2003 [NPR, SRC] and Michaelowa et al. 2005b [NPR, SRC] ) for discussion of a composite index using the sum of per-capita emissions and per-capita GDP and Torvanger et al. 2005 [NPR] ) for further composite indices). Qualitative thresholds such as adherence to certain country groupings (OECD, Economies in Transition) are already in use. Ott et al. 2004 [NPR, SRC] ) combine quantitative and qualitative thresholds. Thresholds can be derived from agreed-upon GHG concentration targets or global emissions paths or be based on other parameters, such as willingness or capacity to pay.

Some have argued that an international agreement needs to include at least the major emitters to be effective, since the largest 15 countries (the EU25 is considered here to be one country) produce as much as 80% of global GHG emissions ( Baumert et al., 2005a [NPR, SRC] ; PEW, 2005; Stewart and Weiner, 2003 [NotFound] ; Torvanger et al., 2005 [NPR] ; Schmidt et al., 2006 [NPR, SRC] ). A similar approach has been taken by authors comparing climate change agreements to other multilateral instruments, including disarmament treaties and the Antarctic Treaty (see Murase, 2002a [SRC] ). In these analyses, the authors assert that success can only be achieved if the major stakeholders act. Thus, for example, a nuclear disarmament treaty would be meaningless if it was not ratified by those States with nuclear weapons, even if it was ratified by the 180 non-nuclear States. By analogy, a climate change treaty is meaningful only if commitments are adopted and implemented by the major emitters – noting that the benefits of participation accrue to all countries, including those not taking part in the agreement. Murase 2002a [SRC] ) suggests that a future regime after 2012 thus needs to include key countries or groups such as the USA, EU, Japan, China, India, Korea, Mexico, Brazil, Indonesia, South Africa and Nigeria.

Much of the literature on game theory suggests that the conditions necessary for achieving large-scale stable coalitions mean that relatively modest emissions reductions will be achieved (e.g. ( Carraro and Siniscalco, 1993; ) ( Hoel and Schneider, 1997 ) ). Cooperative game theory emphasizes the prospect of building stable coalitions if a transfer scheme (e.g. by emissions trading) can allocate the gains from cooperation in proportion to the benefits from reduced climate impacts (e.g. ( Chander and Tulkens, 1995; ) Germain et al., 1998 [NPR] ;( Germain et al., 2003 ) ). Eykmans and Finus 2003 [NPR] ) note that much of the literature focuses on a ‘grand (all party) coalition, analyses stability in terms of the aggregate payoff to coalitions and rests on very strong assumptions about implicit punishment of any free-riding countries.’ A more extensive discussion of the issues of free-riding is contained in Chapter 10 of the TAR.

Alternative assumptions can provide a richer understanding of possible factors relevant to an agreement by relating relate to the response to payoffs from cooperation, including spillover and trade effects, allowing for the development of multiple coalitions and recognizing trade and the role of technology transfer as well as the potential for other transfer schemes ( Tol et al., 2000 [NPR] ; Finus, 2002 [NPR] ;( Kemfert et al., 2004 ) ). They also increase the possibility that partial cooperation (including involving more than one coalition) can close the gap between the global optimum (full cooperation) and “no cooperation” by a substantial amount. While this is essentially a theoretical conclusion (based in some cases on modelling reflecting some empirical evidence), it provides some basis for suggesting that it is too restrictive to assume that a single, all-encompassing global intergovernmental agreement is a necessary condition for effective mitigation action.

Some authors (see, for example, Muller, 2002 [NPR] ; Jaeger, 2003 [NPR] ) suggest that a climate regime is not exclusively about mitigation but that it also encompasses adaptation and, as such, far wider arrays of countries are vulnerable to climate and must be included in any agreement. Further, several authors (e.g. Meira Filho and Gonzales, 2000 [NotFound] ; Pan, 2005 [NPR, ARC] ) argue that even if the majority of emissions are the responsibility of only a few nations, all countries must share the commitments to reduce these for reasons of equity and fairness (recognizing that such actions should be differentiated according to responsibility and capability). Other rationales for global engagement are also used, including that if only some major countries participate, the emissions of non-participating countries could increase by the migration of emission-intensive industries. Therefore, most proposals aim to provide incentives for countries to participate. Some aim at pull incentives, such as temporary over-allocation or no regret structures; others mention push incentives, such as trade sanctions or border tax adjustments ( (Kuik, 2003; ) ( Biermann and Brohm, 2005 ) ).

Other authors argue that countries have differentiated historical responsibility and that such a sub-global participation can be effective: Grubb et al. 2002 [JoC, ARC] ) argue that under some scenarios one can expect that technology development driven by the international climate regime in Annex I countries could offset some or all emissions leakage in non-Annex I countries. Sijm 2004 [NPR, MoS] ) notes that a number of policies could promote this spillover effect in the longer term. These types of policies include international cooperation on Research, Development and Demonstration (RD&D), promoting open trade or using the Clean Development Mechanism. Others argue that with the participation of some large countries, other countries cannot lag behind and that the climate regime should look for that ‘tipping point’ ( Barrett, 2003 [NPR] ).

In general, the literature suggests that actions can occur in parallel and that international agreements could have multiple components, since national circumstances are so diverse. However, the suggestion is also made that care should be taken, particularly for countries with limited institutional capacity, to avoid creating too many simultaneous international activities.

13.3.3.3 Implications of regime stringency: linking goals, participation and timing

Several studies have analysed the regional emission allocations or requirements on emission reductions and time of participation in the international climate change regime with the aim of being able to ensure different concentration or temperature stabilization targets ( Berk and den Elzen, 2001 [JoC, MoS, SRC] ; Blanchard, 2002 [NPR] ; Winkler et al., 2002a [JoC, ARC] ; Criqui et al., 2003 [NPR, SRC] ; WBGU, 2003 [NPR] ; Bollen et al., 2004 [NPR] ; Groenenberg et al., 2004 [JoC, ARC] ; Böhringer and Löschel, 2005 [NPR] ; den Elzen and Meinshausen, 2005 [NPR, SRC] ; den Elzen and Lucas, 2005 [MoS, SRC] , den Elzen et al., 2005c [SRC] ; Höhne et al., 2005 [Ambiguous] ; Michaelowa et al., 2005a [SRC] ;( Böhringer and Welsch, 2006; ) Höhne, 2006 [Ambiguous] ; Persson et al., 2006 [NPR] ). A large variety of system designs for allocating emission allowances/permits were analysed, including contraction and convergence, multistage, Triptych and intensity targets. The studies cover a broad spectrum of parameters and assumptions that influence these results, such as population, GDP development of individual countries or regions, global emission pathways that lead to climate stabilization (including overshooting the desired concentration level), parameters for the thresholds for participation and ways to share emission allowances. For example, the studies include very stringent requirements for developed countries with more lenient requirements for developing countries as well as less stringent requirements for developed countries and more ambitious constraints for developing countries within a plausible range. The conclusions of these studies and their implications for international regimes can be summarized as follows:

• Under regime designs for low and medium concentration stabilization levels (i.e. 450 and 550 ppm CO₂-eq, category A and B; see Chapter 3 , Table 3.10 ) GHG emissions from developed countries would need to be reduced substantially during this century. For low and medium stabilization levels, developed countries as a group would need to reduce their emissions to below 1990 levels in 2020 (on the order of –10% to 40% below 1990 levels for most of the considered regimes) and to still lower levels by 2050 (40% to 95% below 1990 levels), even if developing countries make substantial reductions. The reduction percentages for individual countries vary between different regime designs and parameter settings and may be outside of this range. For high stabilization levels, reductions would have to occur, but at a later date (see Box 13.7 ).
• Under most of the considered regime designs for low and medium stabilization levels, the emissions from developing countries need to deviate – as soon as possible – from what we believe today would be their baseline emissions, even if developed countries make substantial reductions. For the advanced developing countries, this occurs by 2020 (mostly Latin America, Middle East and East Asia). For high stabilization levels, deviations from the reference level are necessary only at a later date.
• Reaching lower levels of GHG concentrations requires earlier reductions and faster participation compared to higher concentrations.
• For many countries, the overall target set is critical; it dictates the emissions reduction requirements more specifically than does the approach chosen to meet that target.
• The wide diversity of approaches means that not all countries participate under all regimes – even if an identical concentration target is achieved. Obviously, required national actions differ enormously, depending on whether a country participates in a system. However, the difference in reductions required between the various approaches is small for participating countries.

Several studies have gone one step further and have, based on emission allocations, calculated emission reduction costs and possible trades of emission allowances at a regional level for different concentration or temperature stabilization targets ( Criqui et al., 2003 [NPR, SRC] ; WBGU, 2003 [NPR] ; Bollen et al., 2004 [NPR] ;( Böhringer and Welsch, 2004, ) 2006; Böhringer and Löschel, 2005 [NPR] ; den Elzen and Lucas, 2005 [MoS, SRC] ; den Elzen et al., 2005c [SRC] ; Persson et al., 2006 [NPR] ). Researchers have also analysed a large variety of system designs. With cost analysis even more assumptions are relevant, such as detailed assumptions on emission reduction costs per sector and region. Costs have been calculated using a variety of models, ranging from those with detailed sectoral representation focussing on the technological aspects to macroeconomic models focussing on the economy as a whole. How (and what) costs are calculated plays a role. Some studies present annual direct mitigation costs (only direct abatement costs) or energy costs, such as mitigation costs and costs of losses of fossil fuel exports or gains from increased exports of biofuels. Other studies present full macro-economic costs, calculated as (cumulative) GDP losses in a specific target year. The cumulative impact of climate policies on GDP may be lower than expected from the annual abatement costs levels due to the fact that climate policy leads mostly to the substitution of investments and activities and much less to an overall reduction of the GDP. The conclusions of these studies on costs can be summarized as follows:

Global costs

• The total global costs are highly dependent on the baseline scenario, marginal abatement costs estimates, the participation level in emission trading and the assumed concentration stabilization level (see also Chapter 11 ).
• The total global costs does not vary significantly for the same global emission level; however, costs will vary with the degree of participation in emission trading (how and when allowances are allocated). If, for example, some major emitting regions do not participate in the reductions and in emission trading immediately, the global costs of the participating regions may be higher (see also Chapter 3 , e.g. Bollen et al., 2004; den Elzen et al., 2005c).

Regional costs

• Regional abatement costs are largely dependent on the assumed stabilization level and baseline scenario. The allocation regime is also an important factor, although in most countries the extent of its effect is less than that of the stabilization level (see Criqui et al., 2003; den Elzen and Lucas, 2005; den Elzen et al., 2006b). The allocation parameter having the largest effect is the timing of participation. Under a staged approach, whether a region participates early or late is of great importance. If, for example, convergence of the per capita emissions were to occur by the end of this century, developing regions would incur high costs relative to what might occur in the reference or baseline cases. Conversely, if convergence were to occur by the middle of the century, developed countries would incur higher costs relative to what they might incur in a reference or baseline case (see Nakicenovic and Riahi, 2003; den Elzen et al., 2005a; Persson et al., 2006).
• Abatement costs (only costs from reducing emissions) as a percentage of GDP vary significantly by region for allocation schemes that ultimately lead to convergence in per capita emissions by the middle of this century. The costs are above the global average for the Middle East and the Russian Federation, including surrounding countries, and – to a lesser extent – for Latin America. The costs are near the world average for the OECD regions and below the world average for China. The other developing regions, such as Africa and South-Asia (India), experience low costs or even gains as a result of financial transfers from emission trading. (Criqui et al., 2003; den Elzen and Lucas, 2005).
• In addition to the abatement costs of reducing emissions, other costs arise from changes in international trade. Fossil fuel-exporting regions are also likely to be affected by losses in coal and oil exports compared to the baseline, while some regions could experience increased bio-energy exports (i.e. the Russian Federation and South America) (see Nakicenovic and Riahi, 2003; van Vuuren et al., 2003; Persson et al., 2006; and also Chapter 11 ).
• The economic impacts in terms of welfare changes show a similar pattern for different allocation schemes. For example, allocation schemes based on current emissions (sovereignty) lead to welfare losses for the developing countries. Allocation schemes based on a per capita convergence lead to welfare gains for developing countries, without leading to excessive burdens for industrialized countries. (Böhringer and Welsch, 2004)

13.3.3.4 Actions

International Emissions Trading

Emissions’ trading has become an important implementation mechanism for addressing climate change in many countries. The overall value of the global carbon market was over 10 billion US$ in 2005, and in the first quarter of 2006 the transaction level reached 7.5 billion US$ (World Bank and IETA, 2006 [NotFound] ).The most advanced ETS is that developed by the EU. While this system is an international one, it bears many of the characteristics of a national programme, with oversight by the European Commission and a centralized regulatory and review mechanism (see Box 13.4 for details, including those on trading prices and volumes). A larger global system of international trading is slowly developing through emission credits generated by the project-based mechanisms. ^[33] Theoretically, a fully global ETS would provide market players and policymakers with information thus far absent from decision-making: the actual, unfettered, global cost of GHG mitigation in a range of economic activities. In this context, at the international level, such a regime would mirror the information provided by national trading programmes at a global scale.

Lecocq and Capoor 2005 [NPR, ARC] ) note that while the international GHG emissions market remains fragmented, trading activity has increased substantially during the last 5 years. According to their analysis, regional, national and sub-national trading programmes are all operating under different rules, which could inhibit ‘market convergence’ and increase the costs of trading. Others indicate that a global market can incorporate diverse domestic and regional systems despite differences in design; they reiterate the point made by others that such a system may be significantly less efficient that a single globally optimized regime ( Baron and Philibert, 2005 [NPR] ).

A full assessment of the elements required to link multiple regimes is provided by Haites 2003a [NPR, SRC] ), who identifies only a few situations that might prevent linkages (a formal prohibition in one system to allow links, and circumstances where a single firm’s membership in multiple programmes creates the potential for double counting). However, issues that could complicate links between two or more emissions trading programmes include concerns on the effectiveness of compliance enforcement and on whether the linked regimes provide adequate protection of either system’s environmental objectives. As Bygrave and Bosi 2004a [NPR] ,b) note, links do not need to be formal; market arbitrage can provide opportunities for purchasing allowances in multiple markets even if there is no specific recognition of one system’s permits under another’s structure.

Various authors have analysed the size of the allowance surplus of the countries in transition, barriers to accessing allowances, the potential market power of cartels and links to energy security. Such surpluses can alter the overall costs of compliance with the Kyoto commitments – but only if trade in such surplus allowances is undertaken. Victor et al. 2001a [NPR] ) estimated the joint Russian and Ukrainian surplus at 3.7 billion tCO₂ for the entire commitment period 2008 – 2012 Berkhout and Smith 2003 [NPR] ) estimate the surplus level of the former Soviet Union through to 2030 and state that it could only cover half of an assumed 30% reduction target for a 28-member state EU Golub and Strukova 2004 [JoC] ) see the Russian surplus as being up to 3 billion tCO₂, arguing that due to barriers in the Russian capital market, forward trading with OECD countries represents the only opportunity to raise initial capital to mobilize no-regret and low-cost GHG reductions. ( Maeda 2003 ) ) shows that permits for surplus emissions in the international emissions trading regime may affect the economic efficiency of the Kyoto mechanism and suggests that considerable market power exerted by sellers could affect the price (e.g. if all of the economies in transition form a cartel, if Ukraine forms a cartel with Russia or even if Russia acts alone). ( Kuik 2003 ) ) sees a trade-off between economic efficiency, energy security and carbon dependency with respect to the EU acquisition of Russian and Ukrainian assigned amount units. One proposal for reducing concerns over trading in surplus allowances is that of the ‘Green Investment Scheme’, in which revenues from sales of surplus allowances are spent on national policies, programmes and projects to further reduce emissions; this option is explained further below.

Project-based mechanisms (Joint Implementation and the Clean Development Mechanism)

The earliest project-based mechanism of the UN Climate Convention process was the pilot phase of ‘Activities Implemented Jointly’ (AIJ). Most of the 150 AIJ projects were small, and many were only partially implemented due to the lack of financing that resulted from the lack of emissions credits. Only half a dozen investor countries and even fewer host countries developed real, national AIJ programmes. Selection criteria for AIJ programmes often delayed the acceptance of projects, and most that were undertaken were commercially viable only if additional financing was provided by a separate investment subsidy ( Michaelowa, 2002 [SRC] ).

Since 2000, the CDM has allowed crediting of project-based emission reductions in developing countries; this is the first of the Kyoto Protocol’s market mechanisms to be implemented. A number of analysts have estimated CDM volume and price. Chen 2003 [ARC] ) derived prices of 2.6–4.9 US$/tCO₂ and annual volumes of approximately 600– 1000 million certified emissions reductions (CERs). Jotzo and Michaelowa 2002 [MoS, SRC] and Michaelowa and Jotzo 2005 [SRC] ) model an annual CER demand of 360 million tCO₂ and a price of 3.6 €/tCO₂ Springer and Varilek 2004 [MoS] ) predict a likely CER price of less than 10 US$/tCO₂ in 2010 . CER prices increased from approximately 3 €/tCO₂ in 2003 to more than 20 €/ton in early 2006 (at the time of peak prices in the EU ETS); as of October 2006, they had declined to about 13 €/tCO₂. CER prices have been relatively closely tied to EU ETS prices over time.

As of May 2006, the volume of CERs estimated from nearly 1000 proposed projects in 69 countries was 200 MtCO₂-eq/year in 2008 – 2012 and 330 Mt MtCO₂-eq/year in the pre- 2008 period ( Ellis and Karousakis, 2006 [NPR] ; specific project information can be found at http://cdm.unfccc.int; recent updates on the CDM/JI pipeline can also be found at the UNEP/RISO site, www.cd4cdm.org/publications/CDMpipeline.xls) (See Figure 13.3 ). While not all projects will be implemented, the UNFCCC cites 491 registered projects and estimates CERs equal to 740 MtCO₂-eq from those projects through to the end of 2012 . ^[34] Ellis and Karousakis 2006 [NPR] ) also indicate that almost half of the proposed CDM projects are in the electricity sector and that many are small renewable projects occurring in 40 countries. However, the majority of credits have come from CDM projects reducing nitrous oxide (N₂O), trifluoromethane (HFC-23) and, to a lesser extent, methane (CH₄). Projects that have not yet had methodologies approved will be under-represented in the project mix – even if they represent opportunities for significant emissions reductions at the national or global level. Publicly committed budgets for CER acquisition stood at approximately 7.5 billion US$ (World Bank, 2006 [NPR] ) (See Figure 13.4 ). At such a scale, the CDM begins to reach the same order of magnitude as Global Environment Facility (GEF) and Official Development Assistance (ODA) resources.

Figure 13.3: Evolution of the Clean Development Mechanism portfolio in terms of CO₂ -equivalents per year and number of projects.

Source: Ellis and Karousakis 2006 [NPR] ).

Figure 13.4: Budgets for the acquisition of certified emissions reductions (CERs) and emission reductions units (ERUs).

Note: Status as of October 10, 2006 at which time the total budget was almost € 6 billion.

It was initially assumed that CDM projects would be undertaken as bilateral arrangements between Annex I and non-Annex I convention Parties (and private sector companies in those countries). As of October 2006, 56% of registered projects were being undertaken unilaterally, indicating that companies in developing countries are procuring the financing to implement projects and sell the CERs to industrialized countries. ^[35]

A CDM project has to go through an elaborate project cycle that includes external validation and which has been defined by a decision of the 7^th Conference of the Parties to the UNFCCC 2001 [NPR] ) and is in keeping with the decisions of the CDM Executive Board that is overseeing the project cycle (see, for example, UNFCCC, 2003a [NPR] –c). As CDM projects are implemented in countries without emissions targets, project ‘additionality’ becomes important to avoid generating fictitious emission reduction credits through ‘business as usual’ activities. Several tests of additionality have been discussed in the literature; these include investment additionality (see Greiner and Michaelowa, 2003 [SRC] ) and environmental additionality (see ( Shrestha and Timilsina, 2002 ) ). The CDM Executive Board has developed an additionality tool that project proponents can use to test and demonstrate the additionality of a CDM project (http://cdm.unfccc.int/methodologies/PAmethodologies/ Additionality_tool.pdf).

If a project is additional, the next step is to determine a ‘baseline’ – the emissions that would have occurred if the project had not taken place. One potential risk is the overestimation of baseline emissions, which is a major problem as all participants profit from an overestimate as there is then no incentive to correct it. Stringent rules and modalities are required for determining baselines affecting the efficient processing of the CDM ( Bailey et al., 2001 [JoC] Fischer 2006 [NPR] ) argues that due to pressure from industry, rules for standard emission rates are likely to be systematically biased to over-allocation and also risk creating inefficient investment incentives. Alternatively, ( Broekhoff 2004 ) ) focuses on costs and efficiency, arguing that the availability of data and the level of data aggregation determine to a large extent the cost of deriving multi-project baselines. Other authors examine specific baseline issues in the energy sector, particularly the use of models, the need to consider size, vintage, generation type and operational characteristics and issues relating to technology and sectoral approaches (see ( Fichtner et al., 2001; ) Zhang et al., 2001 [ARC] ; Spalding-Fecher et al., 2002 [ARC] ;( Begg and van der Horst, 2004; ) ( Illum and Meyer, 2004; ) ( Kartha et al., 2004; ) Rosen et al., 2004 [MoS] ; Sathaye et al., 2004 [ARC] ).

In order to account for any emissions that occur outside of the CDM project boundary but which are a consequence of the CDM project – emissions referred to a ‘carbon leakage’ – a CDM project should also include a leakage estimate. According to the UNFCCC CDM glossary of terms, leakage is defined as the net change of anthropogenic emissions by sources of GHGs that occur outside the project boundary and which is measurable and attributable to the activity of the CDM project. Leakage issues have been discussed by a number of authors (see, for example, Geres and Michaelowa 2002 [SRC] and Kartha et al. 2002 [NPR] ) for the electricity sector and the Working Group on Baseline for CDM/JI Project ( 2001 )). There is a general consensus that the determination of project boundaries is critical to any evaluation of leakage.

The coverage of forestry and forest-related projects is a contentious issue under the CDM. The problems primarily relate to the impermanence of the forest and to leakage to other regions. Dutschke 2002 [ARC] ) suggests leasing CDM credits to address the non-permanence of forestry sinks. The CDM has addressed the issue of non-permanence through the creation of separate CDM credits, which are called temporary CERs. According to Nelson and de Jong 2003 [JoC] ), development priorities can be lost. This is illustrated by the case of a forestry project in Chiapas in which Mexico shifted from a development emphasis with multiple species to two species when the focus changed to carbon sales by individual farmers. Data (or its scarcity) as well as price uncertainty also pose problems. ( Vöhringer 2004 ) ) notes that establishing historical deforestation rates is a major problem in Costa Rica. van Vliet et al. 2003 [JoC] ) analysed six proposed plantation forestry projects in Brazil for uncertainty and, based on their results, they suggest that fluctuations in product prices cause variations of up to 200% in CERs and net present value, leading to difficulties in determining the additionality of such projects, thereby making five of the six projects ineligible for CDM.

Perhaps the most critical issue in the context of the viability of the CDM over the longer term is whether there will be an ongoing price signal that encourages both emission reduction commitments and a market demand – over the longer term. This will clearly depend on the shape of both international agreements and evolving national programmes that might support project offsets. Independent of the market demand issues, an important suggestion to enhance the CDM relates to improving the sustainable development benefits of a CDM. One proposal ^[36] for doing this is the ‘Gold Standard’, which calls for enhanced environmental assessment, stakeholder consultations and the use of a qualitative sustainability matrix, expanding the CDM regime to allow programmes and policies to be credited – a concept elaborated on in a decision by the first meeting of the Kyoto Parties in 2005, and analysed by Ellis 2006 [NPR] ) – and extending CDM project incentives beyond 2012 .

Joint Implementation has been much less extensively researched than the CDM. Its later start date and unclear international rules (for example, the ‘second track’ rules were only agreed upon in October 2006 ) have generated considerable uncertainty with regard to implementation. Transactions under JI are seen as both cumbersome and beset with institutional obstacles ( (Korppoo, 2005 ) ). In addition, several authors have argued that JI projects will potentially be ‘double counted’ – given credit under both the project mechanism as well as under the rules for EU ETS. A number of proposals have been made to address this issue. Koch and Michaelowa 1999 [SRC] ( and Moe et al. 2003 ) ) have suggested a ‘Green Investment Scheme’ (GIS) in which revenues from sales of Assigned Amount Units (AAU) are allocated to projects that reduce GHG emissions. Blyth and Baron 2003 [NPR] ) suggest that the scale of a GIS in Russia could reach as much as € 1.25–3.5 billion per annum. This is a very approximate figure and depends on the balance of supply and demand and the prevailing allowance price. Fernandez and Michaelowa 2003 [JoC, SRC] ) discuss the impact of defining the ‘acquis communautaire’ as the baseline for JI projects in the new EU Member States and stress the need to establish a predictable legal framework in the host countries, while van der Gaast 2002 [NPR] ) sees a reduced scope for JI in Eastern Europe due to the ‘acquis’ which could also be increased by using a GIS.

National institutions for project-based mechanisms have been slow to develop. The institutional problem is often exacerbated in countries with unstable economies and institutions and by project developers who often have very short time horizons, are unwilling to wait for the revenues and who cannot provide regular and ongoing monitoring and verification reports of emission reductions (see Michaelowa 2003a [SRC] ) for an overview of such issues in CDM host countries, ( Korppoo 2005 ) ) for specific issues related to the Russian Federation Figueres,) for specific issues related to the Russian Federation Figueres,) for issues specific to Latin America).

Sectoral approaches

A number of researchers have suggested that sectoral approaches may provide an appropriate framework for post-Kyoto agreements (see sectoral approaches in Table 13.2 ). Under such a system, specified targets could be set, starting with specific sectors or industries that are particularly important, politically easier to address, globally homogeneous and/or relatively insulated from competition with other sectors. Such an approach may be binding (e.g. such as an agreement in the International Civil Aviation Organization) or voluntary (such as an agreement through the International Standardization Organization). Targets may be fixed or dynamic, and ‘no-lose’, binding or non-binding ( Philibert and Pershing, 2001 [JoC, SRC] ; Samaniego and Figures, 2002 [NotFound] ; Bodansky, 2004 [NPR] Bosi and Ellis 2005 [NPR] and Baron and Ellis 2006 [NPR] ) have explored different design options for sectoral crediting, including policy, rate-based and fixed limit approaches, and Ellis and Baron 2005 [NPR] ) have assessed how these options could be applied to the aluminium and electricity sectors.

Sectoral commitments have the advantage of being able to be specified on a narrower basis than total national emissions. Baumert et al. 2005b [NPR, PoC, SRC] ) consider specific options in aluminium, cement, iron and steel, transportation and electricity generation and conclude that while not all sectors are amenable to such approaches, considerable precedent already exists for agreement both between companies and by governments. Sectoral approaches provide an additional degree of policy flexibility and make the comparison of efforts between countries within a sector a relatively easy process – although comparing efforts across sectors may be difficult (see Philibert, 2005a [NPR, MoS] ). An additional disadvantage to sectoral approaches is that they may create economic inefficiency. Trading across all sectors will inherently be at a lower cost than trading only within a single sector.

Technology agreements

The studies reported in the literature make it very clear that R&D support, price signals and other arrangements can all contribute to technology development and diffusion. Financial and human resources, often scarce in developing countries, will be needed to promote R&D, while monetary and political incentives as well as institutional arrangements will be required to promote diffusion (see IPCC 2000 [Ambiguous] ) which contains a comprehensive review of technology transfer issues, including proposals for improving international agreements.) Technology agreements may also seek to address barriers in technology research, development and diffusion. (For additional details on specific sectors and technologies, see Chapters 4 – 10 ).

One variant of a technology agreement is formulated by ( Barrett 2001, ) 2003 ) in a proposal which emphasizes both common incentives for climate-friendly technology research and development (R&D) and technology protocols (common standards) rather than targets and timetables. While this proposal could potentially be environmentally effective, depending on the payoffs to the cooperative R&D efforts and the rate of technology deployment, Barrett notes that the system would neither be efficient nor cost-effective, not least because the technology standards would not apply to every sector of the global economy and may entail some technological lock-in. However, Barrett assumes that if standards are set in enough key countries, a ‘tipping effect’ is created which ultimately would lead to widespread global adoption. In reviewing Barrett’s assessment, Philibert 2004 [NPR] ) expresses doubts as to whether such a tipping effect would be applicable and suggests, alternatively, that for some technologies (e.g. CO₂ capture and storage), cost constraints may be more critical than acceptability in determining market penetration.

The concept of regional technology-specific agreements has also been explored by Sugiyama and Sinton 2005 [NPR, MoS, ARC] ), who suggest that they may offer an interim path to promote cooperation and develop new, lower cost options to mitigation climate change – allowing any future negotiations on emission caps to proceed more smoothly. Box 13.8 lists some examples of existing international technology coordination programmes.

Technology transfer

One mechanism for technology transfer is through the establishment of – and subsequent contributions to – special funding agencies that disburse money to finance emissions reduction projects or adaptation activities. The UNFCCC and the Kyoto Protocol already include provisions for establishing and funding project activities, although contributions to and participation in these are mostly voluntary. UNFCCC also includes provisions for technology transfer under Article 4.5. The CDM could also be a vehicle for technology transfer, but the effects are unclear at this point.

As part of the Marrakesh Accords, at the seventh Conference of the Parties (COP 7), Parties were able to reach an agreement to work together on a set of technology transfer activities, which were grouped under a framework for meaningful and effective actions to enhance the implementation of Article 4.5 of the Convention. This framework ^[37] has five main themes:

1. Technology needs and needs assessments;

2. Technology information;

3. Enabling environments;

4. Capacity building;

5. Mechanisms for technology transfer.

Actions to implement the framework include the organization of meetings and workshops, the development of methodologies to undertake technology needs assessment plans, the development of a technology transfer information clearinghouse, including a network of technology information centres, actions by governments to create enabling environments that will improve the effectiveness of the transfer of environmentally sound technologies and capacity building activities for the enhancement of technology transfer under the Convention. Funding for technology needs assessments has been provided, and further funds for technology may become available from the UNFCCC’s Special Climate Change Fund.

Other international efforts have also been undertaken to promote technology transfer in support of climate change mitigation efforts, including those by the UN Industrial Development Organization (UNIDO) and by the Climate Technology Initiative (CTI) of the IEA. As noted by the US National Research Council, additional work is particularly needed to assist poor countries as these lack scientific resources and economic infrastructure as well as the appropriate technologies to reduce their vulnerabilities to potential climate changes NRC,Other international efforts have also been undertaken to promote technology transfer in support of climate change mitigation efforts, including those by the UN Industrial Development Organization (UNIDO) and by the Climate Technology Initiative (CTI) of the IEA. As noted by the US National Research Council, additional work is particularly needed to assist poor countries as these lack scientific resources and economic infrastructure as well as the appropriate technologies to reduce their vulnerabilities to potential climate changes NRC,).

The distinction between public financing for climate change mitigation and private financing for technology investment is often blurred: Clean energy projects are frequently a blend of the two, with public financing used to leverage private investment. For example, the International Finance Corporation (IFC) clean energy financing projects in Eastern Europe, Russia, China and the Philippines use technical assistance funds to train commercial banks in energy efficiency while concurrently lending partial risk guarantees and offering credit lines to encourage banks to provide loans. In this manner public funds are heavily leveraged and provide a source financing for clean energy investments. ^[38]

Development oriented actions

A ‘Sustainable Development Policies and Measures’ (SDPAMS) approach proposed by Winkler et al. 2002b [NPR, ARC] ) and further elaborated by Bradley et al. 2005 [NPR, PoC, SRC] ) focuses on linking climate mitigation and adaptation to priority development needs. In its standard form, such an approach would be domestic and unilateral and – with its focus on developmental needs – would also bring GHG benefits. However, the authors also suggest that simultaneous SDPAMS pledges (and possibly harmonized pledges) could be made by both developing and developed countries. However, Bradley et al. 2005 [NPR, PoC, SRC] ) do note several limits to this approach and suggest that it may not be suitable for developed countries, nor for every technology or policy. Finally, they note that SDPAMS may not attract the necessary funding for it to be implemented on the scale required for global climate change mitigation.

13.3.3.5 Financing

Funding sources for GHG mitigation in developed and developing countries is a crucial issue in the international debate on tackling climate change. Financing is categorized in the literature in terms of public flows (including Development Assistance and government loan guarantees through export credit agencies), private flows or foreign direct investment (FDI) and financing from multilateral institutions, including the Global Environment Facility (GEF) and international financial institutions. Public financing is the main form of assistance for developing country climate change mitigation, while the private sector provides the technology investments. CDM resources are significant when compared with GEF funding, but small in comparison to FDI resources ( Ellis et al., 2007 [ARC, 2007] ). In addition to these instruments, a World Bank survey of contingent financing and risk mitigation instruments for clean infrastructure projects describes the characteristics and potential use of other instruments, such as insurance, reinsurance, loan guarantees, leases and credit derivatives ^[39] ( IPCC, 2000 [Ambiguous] ; World Bank, 2003 [NPR] ). A small percentage of public funds are used to leverage private investment in clean energy projects.

13.3.3.5.1 Foreign direct investments

OECD trade and FDI have grown strongly in relation to GDP during the past decade: cumulative net FDI outflows between 1995 and 2005 amounted to 1.02 trillion US$. As a share of GDP, outward FDI grew from 1.15% of the GDP in 1994 to 2.02% in 2004 . However, while the total sums grew, only 35% went to non-Annex I countries – and of that, nearly 70% went to five countries, namely China (including Hong Kong), Brazil, Mexico, Singapore and South Korea. ^[40] See also OECD 2005 [NPR] d) for trends in FDI relative to ODA.

One common assertion in international environmental negotiations is that FDI promotes sustainable development as multinational corporations (MNCs) transfer both cleaner technology and better environmental management practices. However, empirical studies find little evidence that MNCs transfer either significant cleaner technology or better practices. In statistical studies of Mexico (manufacturing) and Asia (pulp and paper), foreign firms and plants performed no better than domestic companies ( Zarsky and Gallagher, 2003 [NPR] ). According to Jordaan 2004 [NPR] ) the externalities from the presence of foreign-owned firms do not occur automatically, but are dependant on underlying characteristics of the industries and manufacturing firms.

Most FDI in developing countries is targeted to activities such as the extraction of oil and gas, manufacturing and electricity, gas and water, which have the aim to improve economic development but also to increase GHG emissions ( Figure 13.5 Maurer and Bhandari 2000 [NPR] ) report that during the mid- to late- 1990 s the major developed countries co-financed energy-intensive projects and exports valued at over 103 billion US$ through their export credit agencies (ECAs). These projects and exports included oil and gas development, fossil fuel power generation, energy-intensive manufacturing, transportation infrastructure and civilian aircraft sales. These countries accounted for 90% of the co-financing provided by ECAs to these energy-intensive exports and projects. By comparison, industrialized countries have directed just a fraction of their ECA financing to renewable energy projects. Between 1994 and 1999 ECAs supported a total of 2 billion US$ in renewable energy projects.

Figure 13.5: Total OECD foreign direct investment (FDI) outflows to selected sectors.

Source: OECD 1999 [NPR] )

13.3.3.5.2 Direct international transfers

Official development assistance (ODA) remains an important source of financing for those parts of the world and sectors where private flows are comparatively low, although this is a modest financial resource relative to global private direct investment, which was 106 billion US$ in 2005 . Data from the OECD suggest that development assistance for energy projects (approximately 3.2 billion US$ in 2004 ) from bilateral sources has remained relatively flat over the last 6 years.. There has been a shift in support away from coal technologies to those of gas and some extent renewables ^[41] (see Figure 13.6 ).

The effectiveness of ODA depends on various factors, the most important of which are good governance, policy and institutional frameworks that encourage private investment (macroeconomic and political stability, respect for human rights and the rule of law), minimum levels of investment in human capital (education, good health, nutrition, social safety nets) and policies and institutions for sound environmental management.

Figure 13.6: Development assistance for energy

Source: OECD.

13.3.3.6 Capacity building

The literature on climate change has not addressed capacity building to any extent, despite its critical relevance to the climate change issue. Part of the solution to the climate change problem has been cast in terms of helping developing countries with technology transfer and assistance. The importance of this is recognized in the text of the UNFCCC and Kyoto Protocol as well as in the more detailed implementing framework of the Marrakech Accords.

The capacity building framework within the climate change regime focuses on developing the capacity in developing countries to implement decisions. Capacity building has been defined historically as the formal training of employees, technological gate-keeping and learning-by-doing, with the recognition that this is a slow and complex process. According to Yamin and Depledge 2004 [NPR] ), the Marrakesh Accords have been partially successful in bringing some additional coherence, coordination and prioritization into the process of capacity building. These authors argue that the effort to promote country-driven and contextually tailored efforts that are both iterative and involve learning-by-doing are appropriate.

Other ideas on capacity building also abound. ( Sagar 2000 ) ) argues that it may be more relevant to strengthen the domestic capacity for undertaking policy research and innovation as well as for managing technological and institutional change rather than merely creating the capacity for implementing policies developed elsewhere. This proposal is based on the idea that only context-relevant policy instruments are likely to work within the specific domestic circumstances of the relevant countries.

A number of recent analyses carried out on this subject have questioned whether capacity building can be initiated from outside a country. Since capacity issues are embedded in local contexts, the OECD has argued that it may be a mistake to assume that capacity building can be easily accomplished from outside this context.

Najam et al. 2003 [JoC, ARC] ) note the importance of capacity building for developing countries and require that it be an integral part of any future agreement if it is to have wide support from this group. In particular, they argue that inasmuch as efforts to combat climate change and promote sustainable development are ‘two sides of the same coin’ enhancing the capacities of communities and countries to fight climate change will have multiple benefits. They also make the case that the most pressing need in this context is to strengthen the social, economic and technical resilience of the poorest and most vulnerable countries against extreme climatic events.

13.3.3.7 Compliance

Using game theory, Hovi and Areklett 2004 [NPR, MoS] ) argue that a compliance system has to meet several criteria: (1) consequences of non-compliance have to be more than proportionate; (2) punishment needs to take place when behaviour is suboptimal; (3) an effective enforcement system must be able to curb collective as well as individual incentives to cheat. The compliance system agreed under Kyoto is viewed as only partially fulfilling these criteria. For example, ( Nentjes and Klaassen 2004 ) ) note that the obligation to fully restore any excess emissions in subsequent periods does not exclude the option of postponing restoration forever. If such an outcome occurs, the trading mechanisms under the Protocol may be substantially weakened. However, it is pointed out that introducing adversarial elements (such as sanctions) into the system are highly undesirable in view of the fact that the Kyoto Protocol currently covers only one third of the total GHG emissions of the world ( Murase, 2005 [SRC] ).

There are two schools of thought regarding the appropriate response to non-compliance contemplated under the Kyoto Protocol (see Murase, 2002b [SRC] ). One view advocates ‘soft’ compliance-management, which favours primarily facilitative and promotional approaches by rendering assistance to non-compliant States; those holding this view often refer to ‘the non-compliance procedure’ used under the Montreal Protocol. The other view takes a ‘hard’ enforcement approach in order to coerce compliance by imposing penalties or sanctions on non-complying parties. Financial penalties and economic or trade sanctions have been proposed along these lines. However, it has been suggested that such measures could be in conflict with WTO/GATT rules on trade liberalization ( Mitchell, 2005 [NPR] ).

A more nuanced view is provided by Wettestad 2005 [NPR] ), who concludes that there are eight lessons to be learnt from other regimes. These include the need for an institutional warm-up period, wise institutional engineering, moderate expectations from the verification process, increased transparency, efforts to maintain close cooperation between the Facilitative and Enforcement Branch of the Compliance Committee, the search for opportunities to engage civil society in the process and a focus on assistance and compliance facilitation using the enforcement mechanism as an important but ‘hidden’ stick.

In his review of the Kyoto Protocol’s compliance mechanism, Barrett 2003 [NPR] ) argues that failure to comply over two compliance periods can essentially be equivalent to indefinitely postponing action: A country that is found in non-compliance in the first period has to make up the difference plus 30% in the next period. If it fails to achieve the latter target as well, it will have to make up the difference in the period thereafter – a process that can continue indefinitely. Perhaps the most important point in his proposal is that if countries feel that they cannot easily meet their commitments, they will negotiate for higher allowances in the period thereafter – or even withdraw from the agreement entirely. He also notes that the Protocol does not have any procedures to deal with countries that decide not to cooperate with the rules.

There is a significant body of research that compares various dispute settlement procedures. A number of these assessments examine environmental agreements (see, for example, Werksman, 2005 [NPR] ), while others more specifically focus on possible conflicts between climate agreements and trade agreements (see, for example, Murase, 2002b [SRC] ). With respect to the latter, Murase notes the need for a coordinating authority to be established between a multilateral environmental agreement (MEA) and the WTO. Given that MEAs and the WTO are independent treaties on equal footing, neither can automatically be given the right to make a decision in the case of a conflict. As a result, a number of authors (e.g. Esty, 2001 [JoC] ; Murase, 2002b [SRC] ) have called for the establishment of a new institution, such as a World Environment Organization (WEO), that would embody its own dispute settlement mechanism. This institution would function as a counterpart of WTO by attaining an equal footing between the two regimes.

13.3.3.8 Adaptation

The element of adaptation in international climate agreements has been far less explored to date than mitigation. ^[44] While most authors agree that adaptation is a vital part of a future agreement (although ( Schipper 2006 ) ) suggests that it was not a key focus of the initial UNFCCC negotiators), there is little mention in climate change literature of concrete proposals detailing the actions or obligations that should be undertaken by countries. Most proposals focus on leveraging funding for adaptation activities with an additional set of proposals addressing more specifically the links between adaptation, vulnerability and development agendas (see, for example, Najam et al., 2003 [JoC, ARC] ).

Parry et al. 2005 [NPR, ARC] ) develop an assessment of how adaptation may be incorporated into a future climate change architecture. They begin by noting that much of the adaptive response is likely to be local and, consequently, it is less conducive to a common international approach. Instead, they argue that a key need will be for efforts to incorporate adaptation into development policies and practices, including local, sectoral and national decision-making – a process they refer to as ‘climate-proofing’. At the local level, this would incorporate strategies for municipal planning, including developing and maintaining seed banks, emergency preparedness services and community social services. At the sectoral level, it would include efforts to build climate into infrastructure design and maintenance codes and standards. At the national level, it would include integration into national planning and budget processes – for example, by examining whether planned expenditures will increase exposure to the impacts of climate change – and by doing so, minimize the financial risk, promote macro-economic stability and set aside sufficient funds to manage the consequences of climate shocks. Finally, at the international level, they suggest that key opportunities exist for integrating adaptation into the Millennium Development Goals and into lending practices of international institutions and bilateral aid agencies.

Three funds have been created under the UNFCCC and the Kyoto Protocol to manage adaptation issues: the Least Developed Countries Fund, the Special Climate Change Fund (both under the UNFCCC) and the Adaptation Fund (under the Protocol). In addition, the GEF has been requested to consider adopting more flexible approaches to funding adaptation (though this may not happen with core GEF funds, but with new money from these other funds that would be disbursed by the GEF).

Corfee-Morlot et al. 2002 [NPR] ) suggest that it would be unrealistic to expect the GEF to cover the full cost of adaptation as such expenses would quickly exhaust their resources. Huq and Burton 2003 [NPR] ) propose integrating adaptation into the mainstream work of development agencies, thereby allowing for more cost-effective and wider ranging support. However, as noted by ( Huq and Reid 2004 ) ), doing so runs the risk of diluting other existing aid efforts – which often have considerably higher priorities in-country than climate change adaptation.

The potential role for private (and public) insurance has also been suggested as a possible mechanism to pay for adaptation (e.g. Bals et al., 2005 [NPR] Parry et al. 2005 [NPR, ARC] ) list possible insurance schemes and risk transfer instruments, including:

• An international insurance pool (a collective loss-sharing fund to compensate victims of climate change damages);
• Public-private insurance partnerships (where the insurer is the government, but policies are developed and managed by the private sector);
• Regional catastrophic insurance schemes (regional cash reserves are pooled through mandatory contributions from member governments, and reserves are used for weather-related catastrophes);
• Micro-insurance (risk pooling for low-income individuals affected by specific risks);
• Catastrophe bonds (giving private insurers protection against extreme events; capital is provided by large institutional investors);
• Weather derivatives (financial mechanisms to hedge financial risk from catastrophic weather events)
• Weather hedges (providing protection for farmers; currently sold by banks, farm cooperatives and micro-finance institutions).

13.3.3.9 Negotiating process

It is important that several technical issues be taken into consideration when an agreement is negotiated and implemented. Since the international negotiation process under the UNFCCC is based on decisions by consensus, an approach that is simple and requires a small number of separate decisions by international bodies most likely has a higher chance of being agreed upon. This may be true of any agreement that engages multiple countries.

It has been reported in the literature that ownership of an instrument – and hence its commitment and effectiveness – is linked to the manner in which the agreement was negotiated, and that the leadership (directional, instrumental and structural) demonstrated in a regime may stimulate its effectiveness. ( Kanie 2003 ) ) concludes that in the EU, the introduction of policies and measures and institution building changed the dynamics of the climate change negotiation process by enhancing leadership capacity.

The role and influence of non-State actors in the process of negotiation also increase the legitimacy and compliance-pull of a regime, both because such participation promotes the broader acceptability of the agreement and because it may increase knowledge about the regime. Agreements are also more likely to be effective when they are negotiated in accordance with established rules of procedure, when the negotiators of key countries have been able to adequately prepare themselves for the negotiation and when the subject matter of the negotiations is designed to address the problem and has not been artificially limited to make the solutions more attractive to the more powerful countries ( (Andresen and Wettestad, 1992; ) Benedick, 1993 [NPR] ; Sebenius, 1993 [NPR] ; Greene, 1996 [NPR] ; Gupta and Grubb, 2000 [NPR, SRC] ; Gupta and Ringius, 2001 [NPR, SRC] ). The attention of the regular media to climate negotiations can also mobilize awareness of the issue which then increases pressure on the negotiators to achieve a result ( Newell, 2000 [NPR] ).

13.3.4.1 Environmental effectiveness

Environmentally effective international agreements lead to reductions in global GHG emissions and/or concentrations or to decreased climate impacts. The literature suggests that to achieve such success, agreements must provide incentives or deterrents to both State and individual behaviour in order to achieve a specific outcome. However, at the international level, there is some dispute as to whether agreements change trends, or merely codify actions already underway.

An additional critical element in the effectiveness of an international agreement is that of the implementation context: The relevant literature shows that agreements tend to be more successful in countries with both a high level of domestic awareness and resources and a strong institutional and legal framework and where there is clear political will. Where global agreements are designed using only blue-print approaches to instruments, these instruments may ultimately ignore the specific cultural and institutional contexts within which they are designed to function and may actually not work as well (see conclusions of the Millennium Ecosystem Assessment, 2005 ). Agreements that promote ancillary objectives, such as reductions in ordinary air pollution levels, also have a higher chance of success.

An agreement that includes a limited group of countries (particularly if they are not major emitters) may be less effective – and this weakness may be exaggerated when emissions of non-participating countries increase by the migration of emission-intensive industries. Conversely, additional benefits may accrue due to technology spillover that may enhance environmental effectiveness (see Section 13.3.3.2 ).

The timing of an agreement’s provisions may also affect its effectiveness: Focusing only on longer term emission reductions (as suggested under some forms of technology agreements) may preclude the possibility of reaching low climate stabilization levels, as many lower levels require immediate emission reductions.

13.3.4.2 Cost-effectiveness

A cost-effective international agreement would minimize global and national costs and provide participating sovereign nations with sufficient flexibility to reach their commitments in a fashion tailored to their national needs and priorities. To achieve this, agreements would need to avoid being prescriptive in its actions but, instead, leave room for the implementation of the target, (e.g. while reducing emissions in different sectors or reducing the emissions of different gases, they should not create significant distortions in competitiveness between countries).

Many analysts argue that the most cost-effect system would be one which enables emission trading with the broadest possible participation of countries. Such a system would allow the emission reductions to occur in those countries, sectors and gases where they can be achieved at the lowest cost. An approach based on specific policies and measures would have to be designed carefully to be as efficient as an emission trading system. The flexibility provided to private actors in a trading regime also increases the system’s cost-effectiveness.

13.3.4.3 Distributional considerations, including equity

Perhaps the most politically charged issue in international negotiations is that of equity. Whether a system of national emission targets within an international agreement can be conducive to social development and equity depends on participation and the initial allocation of emission rights. For example, Pan 2005 [NPR, ARC] ) suggests that all countries should participate – but that emissions associated with basic needs should be exempt from limits, while emissions associated with luxury activities should be constrained. Conversely, Gupta and Bhandari 2003 [NPR, MoS, SRC] ) suggest that in the initial stages of an agreement, obligations should only be assigned to a limited set of (wealthier) parties. Exemptions to sectors or countries and modifications to the allocation of obligations can help address equity issues.

A sectoral or technology approach would require multiple decisions: which sectors, which types of technologies, and how to regulate or support them. Choosing the sectors (and determining sectoral boundaries) or technologies for agreement may be difficult – unless participation were voluntary (e.g. the current suite of IEA implementing agreements, or the bilateral and multilateral efforts on specific technologies). This may require compromises on environmental effectiveness and equity. In addition, the assessment of whether a country had fulfilled its obligations would be complex. Philibert 2005a [NPR, MoS] ) notes that determining the effectiveness of technology or sectoral agreements could be difficult. In the case of a technology approach, definitive conclusions would likely be delayed until the technologies began to diffuse – and that could mean concomitant requirements for establishing long-lived institutions. The establishment of international institutions to manage coordinated policies and measures or development-oriented approaches may also be complex. While some private sector international institutions exist (e.g., the Aluminium Institute, which has set targets for GHG reductions in aluminium processing among its member companies), most sectors do not have such institutional arrangements. Similarly, while there are institutions designed to promote development (e.g., the Bretton Woods institutions), few have integrated climate change into their portfolios (see Maurer and Bhandari, 2000 Kanie [NPR] , Maurer and Bhandari, 2000 Kanie [NPR] ) argues that while the Kyoto Protocol will remain the core of the institutional system, a network will ultimately be both necessary – and increase effectiveness. The creation of a web of institutions tackling climate change and related issues not only ensures that any shortcoming in one institution does not lead to the collapse of the whole system, but it also enhances collective strength.

13.3.4.4 Institutional feasibility

Two aspects of institutional feasibility are critical in reaching successful international agreements: (1) negotiating and adopting an agreement and (2) the subsequent (usually national) implementation of that agreement.

Since international agreements are usually adopted by consensus, successful agreements are often relatively simple and require only a limited number of separate decisions by international bodies. In addition, global agreements usually require that all data and tools necessary for enforcement be widely available and verifiable (or if not, that they become available in the future). While there has been no comprehensive critique of the proposals in Table 13.3 in terms of their institutional feasibility, the latter clearly varies widely – for example, in terms of the extent to which they try to accommodate national circumstances and different levels of technical sophistication. Hence, the feasibility of reaching agreements will also vary accordingly.