Global Climate Change Mitigation: Strategic Incentives.

• Author: Perdana, Sigit

1. INTRODUCTION

   Even in countries that are signatories to the Kyoto Protocol and the more recent the climate convention on COP 21 Paris, policies restricting carbon emissions remain controversial (Cooper et al., 2016; Dimitrov, 2016). Indeed, current evidence suggests that these agreements have not been effective in mobilizing all signatories to reduce emissions. This ineffectiveness can be explained by disagreement over the scale of mitigation costs (Mahapatra and Ratha, 2017), the weakness of voluntary agreements in the presence of a "tragedy of the commons" (Fehr and Gachter, 2000; Clarke and Waschik, 2012), tardiness in some large economies in the implementation of emission controls (Falkner, Stephan and Vogler, 2010), strong political preferences to free ride (Hovi, Sprinz and Bang, 2010) and the issue of carbon leakage (Burniaux and Martins, 2012).

   Yet all these perspectives rest on the presumption that, for no country or cohesive economic region is there a unilateral gain from mitigation policy. Moreover, even if the very large economies did perceive unilateral gains, those would not be large enough to justify side payments that might induce free riders to participate. These are empirical questions, answers to which this paper contributes.

   The particular literature complemented is that addressing these strategic interactions, led by Nordhaus (2015) and the follow- up studies by Saelen (2016) and Hovi et al. (2017). Nordhaus uses the Coalition-DICE Model and an "evolutionary algorithm approach" to examine the potential for international "clubs" that implement uniform carbon taxes with target prices that range between 12.5 USD and 100 USD per ton of CO2. A uniform carbon pricing regime without trade sanctions is shown to lead only to a non-cooperative equilibrium with minimal abatement. It is concluded that non-participation is the best strategy even for the larger key players: China, the United States (U.S.) and the European Union (EU). More generally, these studies suggest the need for penalties in the form of trade tariffs in order that stable coalitions should be formed. (1)

   This paper commences with a detailed meta-analysis of benefits from mitigation that link carbon emissions to average surface temperature and then to region-specific changes in economic welfare. These results are then combined with region-specific mitigation costs that are calculated using a dynamic model of the global economy that is more highly disaggregated across products and regions than has been used in the previous studies. The level of disaggregation is particularly useful in capturing the interactions across regions that operate through changes in the terms of trade and the global distribution of investment that, in turn, stem from the implementation of mitigation policies alone. Net costs thus calculated are then combined with the results from the meta-analysis to construct matrices of regional payoffs in 2015 present values that are amenable to analysis as multi-player normal form games.

   For reasonable ranges of parameters such as the discount rate, critical mass turns out to be smaller than the individual contributions of the two largest economies, the U.S. and China, so that they would be unilateral gainers from the adoption of carbon taxation. They contribute large enough shares of global carbon emissions that the gains from their abatement alone exceed their mitigation costs. It follows, then, that a "climate club" comprising the U.S., China, and Europe, would also be a unilateral gainer. Moreover, their collective net gains in present value terms prove sufficient to finance side payments that are would induce universal adoption. Nonetheless, the net gains do not turn positive in any region for two decades, rendering these policy outcomes politically difficult to achieve.

   Section 2 briefly reviews the substantial prior literature on strategic interactions influencing potential agreement on climate policy and draws contrasts with the work to be presented. Section 3 introduces the global modelling of mitigation costs and their distribution and section 4 reviews studies that quantify the climate impacts of different levels of mitigation and their consequences for global economic welfare, combining these in a meta-analysis. Section 5 uses the results from the previous two sections to construct multiplayer normal form games and to derive policy-relevant equilibria. The section 6 then concludes and summarizes the research findings.

2. CLIMATE POLICY INTERACTION AND STRATEGIC BEHAVIOUR

   The prior literature on the topic of this paper is both rich and vast. Here we mention only those studies most relevant to the research to be subsequently presented, with the purpose of clarifying our mission in the context of this literature and highlighting key points of difference. A major concern in studies like this is the prospect of regionally heterogeneous climate policies. Accounting for these is a herculean task for analysts and one that we will avoid, choosing instead to imagine that regional policies have equivalents in carbon taxation and that the policy choice is simply whether or not to implement a rate of US$ 20 per tonne. (2)

   The most prominent work on strategic carbon abatement policy interactions at the global level is represented in the suite of articles by Nordhaus and Yang (1996), Nordhaus and Boyer (1999), Nordhaus and Yang (2006), Nordhaus (2010; 2011; 2014). It employs two models of the global economy, namely DICE, which is dynamic and global in scope but highly aggregated, and RICE, in which the world is divided into several regions. These models integrate the climate sector with the global economy, and each country is assumed to produce a single commodity for either consumption or investment, based on Cobb Douglas technology. Nordhaus (2015) assesses climate policy coalitions and examines the role of trade sanctions, imposed for stability, using the Coalition-DICE (C-DICE) model. In this work macroeconomic, bilateral trade and environmental data are used to determine each country's strategic incentive to join a coalition of countries adopting abatement policies. Payoffs are impacts on net national income and countries interact on carbon prices and punitive tariffs.

   Saelen (2016) and Hovi et al. (2017) extend the work of Nordhaus by considering the potential of transfer payments to induce full participation. They use a simple and stylized binary decision model with empirical foundations, which includes population and GDP levels, associated emissions and vulnerability to climate change. Saelen's results indicate that there is substantial potential for side payments to facilitate an effective club. Hovi et al. extend Saelen's work and offer a more regionally disaggregated approach emphasising the importance of initiation by the large emitters, particularly the U.S. and the EU. They classify each country into two types, reluctant or enthusiastic, based on assumptions about intrinsic motivation to start a climate agreement.

   A number of points of difference arise between these prior works and ours to follow. First, we follow the critique of Bohringer et al. (2017) and build on the innovative work of the Nordhaus team by using a model with fully endogenous financial flows and resulting capital growth paths and a level of disaggregation that enables the capture of both the leakage of emissions through trade in energy products and the effects of terms of trade changes due to carbon taxation in one region on the net gains achieved by others. One result of this approach is that the costs of participation differ significantly between regions and over time, as do the benefits at the regional level that are derived from our meta-analysis. We capture all the relevant dynamics and regional interactions but make the assumption that regional governments are able to pre-commit to mitigation policies at the outset, depending on their assessments of discounted net present values of economic gains over the coming 50 years.

   As to coalition stability, we recognise that self-enforcing structures (Barret 1994; 2003) are required. The more members the greater are the incentives to free ride. (3) If there are regions that derive unilateral benefits from implementing abatement policy but benefit further if other regions join, then coalition stability is readily retained by the conditionality of side payments. (4) We give emphasis to positive side payments, rather than punitive tariffs, following Saelen (2016) and Hovi et al (2017), but evaluate the affordability of side payments by comparing them with the measured present value of the net benefits from global abatement that accrue to the initiating region. (5) In the interests of analytical economy, however, we imagine that there is only one policy choice, as between the status quo and a US$20 carbon tax, and that governments commit as of 2015 to a once and for all policy choice based on the net present value of net regional benefits. We begin with the modelling of costs in the section to follow.

3. ESTIMATING THE FUTURE ECONOMIC COSTS OF CARBON ABATEMENT

   This work proceeds in two phases. First, a dynamic model of the global economy is adapted to the assessment of carbon taxation at the regional level. We then describe the structure chosen and the database used. The first application is the construction of a baseline projection of global economic performance through 2050. In subsequent sections our analysis of the cost side is superimposes on this projection a number of alternative mitigation scenarios.

   The model is an extension and adaptation of the Gdyn-E model of Golub (2013). The embodied dynamics accommodate current account imbalances, international capital mobility and capital accumulation via an adaptive adjustment theory of investment at the country or regional level. The database for the model draws on the Global Trade Analysis Project (GTAP-7). It includes five primary...