A Climate Club Approach to International Agreements

An interesting new paper by economist William B. Nordhaus of Yale, which applies some theory and models to try and gleam some insights on the challenges associated with international climate agreements. The author chalks the problem up to free riders.

Subject to many deep uncertainties, scientists and economists have developed an extensive understanding of the science, technologies, and policies involved in climate change and reducing emissions. Much analysis of the impact of national policies such as cap-and-trade or carbon taxes, along with regulatory options, has been undertaken. Notwithstanding this progress, it has up to now proven difficult to induce countries to join in an international agreement with significant reductions in emissions. The fundamental reason is the strong incentives for free-riding in current international climate agreements. Free-riding occurs when a party receives the benefits of a public good without contributing to the costs. In the case of the international climate-change policy, countries have an incentive to rely on the emissions reductions of others without taking proportionate domestic abatement. To this is added temporal free-riding when the present generation benefits from enjoying the consumption benefits of high carbon emissions, while future generations pay for those emissions in lower consumption or a degraded environment. The result
of free-riding is the failure of the only significant international climate treaty, the Kyoto Protocol, and the difficulties of forging effective follow-up regimes.

The author points towards the 1648 Westphalia treaty, which spells out the central principles of modern international law, as a major contributing factor to the status quo. One solution, he posits, might be a ‘Climate Club’ approach:

The idea of a Climate Club should be viewed as an idealized solution of the free-riding problem that prevents the efficient provision of global public goods. Like free trade or physics in a vacuum, it will never exist in its pure form. Rather, it is a blueprint that can be used to understand the basic forces at work and sketch a system that can overcome free-riding. Here is a brief description of the proposed Climate Club: the club is an agreement by participating countries to undertake harmonized emissions reductions. The agreement envisioned here centers on an “international target carbon price” that is the focal provision of an international agreement. For example, countries might agree that each country will implement policies that produce a minimum domestic carbon price of $25 per ton of carbon dioxide (CO2). Countries could meet the international target price requirement using whatever mechanism they choose—carbon tax, cap-and-trade, or a hybrid. A key part of the club mechanism (and the major difference from all current proposals) is that nonparticipants are penalized. The penalty analyzed here is uniform percentage tariffs on the imports of nonparticipants into the club region. Calculations suggest that a relatively low tariff rate will induce high participation as long as the international target carbon price is up to $50 per ton. An important aspect of the club is that it creates a strategic situation in which countries acting in their self-interest will choose to enter the club and undertake high levels of emissions reductions because of the structure of the incentives. The balance of this study examines the club structure more carefully and provides an empirical model to calculate its effectiveness.

The results appear to be quite bleak for schemes without a penalty component:

Here is the bottom line: the present study finds that without sanctions there is no stable climate coalition other than the noncooperative, low-abatement coalition.

Mathematical elements of the paper are particularly of interest (and at times eerily familiar) to me right now as I’ve been working with some of my graduate students over the last few years on applying similar ideas to another of the ‘commons’, water.