Pegram Lecture 2, August 10, 2012

Columbia Consortium for Risk Columbia Consortium for Risk Management (CCRM) Management (CCRM)

www.columbiariskmanagement.net www.columbiariskmanagement.net

11

Economic Returns from Economic Returns from the Biospherethe Biosphere

Pegram Lecture No 2Pegram Lecture No 2Brookhaven National Laboratories, LI Brookhaven National Laboratories, LI

New YorkNew York

Graciela ChichilniskyGraciela Chichilniskywww.chichilnisky.comwww.chichilnisky.comColumbia UniversityColumbia University



22

Human beings, or their close genetic relatives, Human beings, or their close genetic relatives, have lived on Earth for several million yearshave lived on Earth for several million years

Yet only recently has human activity reached Yet only recently has human activity reached levels at which it can affect fundamental natural levels at which it can affect fundamental natural processesprocesses

the concentration of gases in the the concentration of gases in the atmosphere (CO2, Ozone)atmosphere (CO2, Ozone)

the planet’s water massthe planet’s water mass The complex web of species which The complex web of species which

constitute life on earthconstitute life on earth



33

Changes in global atmospheric composition Changes in global atmospheric composition

Atmospheric Concentration of CO2 , 1959-2000

280

290

300

310

320

330

340

350

360

370

380

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999Carb

on

Dio

xid

e M

ixin

g R

ati

o (

pp

m)

Atmospheric Concentration of CFC-12, 1978-2001

0

100

200

300

400

500

600

1978 1982 1986 1990 1994 1998

CFC

-12

Mix

ing

Rati

o (

pp

m)

Atmospheric Concentration of Methane, 1986-2001

1,560

1,580

1,600

1,620

1,640

1,660

1,680

1,700

1,720

1,740

1986 1990 1994 1998

Meth

an

e M

ixin

g R

ati

o (

pp

m)

Fossil Fuel Consumption

Forest Burning

Refrigerants

Foam Blowing

Solvents

Rice Paddies

Marshlands

Cattle

Sources:

The Facts - Trace Gas Concentrations are increasing

Source: World Resources Institute, 2002



44



55

Source: National Oceanic and Atmospheric Administration (NOAA). US Department of Commerce. http://www.noaa.gov/



66

Policy responses to Policy responses to Atmospheric ChangesAtmospheric Changes

1988: Intergovernmental Panel on 1988: Intergovernmental Panel on Climate Change is createdClimate Change is created

Ultimate global authority on climate Ultimate global authority on climate change issues – US is part of itchange issues – US is part of it

1992: Rio UN Earth Summit targets - 1992: Rio UN Earth Summit targets - roll back industrial countries emission roll back industrial countries emission to 1990 levels by 2000to 1990 levels by 2000

A long road since RioA long road since Rio



77

Sources: “A timeline of climate change” Matthew Knight, CNN science, 14, May 2008. http://www.cnn.com/2008/TECH/science/03/31/Intro.timeline/index.html (the rest came from G. Chichilnisky directly).



88

How to achieve the Rio targets?How to achieve the Rio targets?Proposals:Proposals:

Global carbon taxes (OECD Study, Global carbon taxes (OECD Study, 1993 – 41993 – 4

Global markets for carbon emission Global markets for carbon emission permits (Chichilnisky’s proposals: 1 permits (Chichilnisky’s proposals: 1 1. proposal to OECD, 1993, 2. 1996 & 1. proposal to OECD, 1993, 2. 1996 & 1997 proposal to UN Framework 1997 proposal to UN Framework Convention on Climate Change, Chair Convention on Climate Change, Chair R. Estrada-Oyuela, and 3. proposal to R. Estrada-Oyuela, and 3. proposal to World Bank 1995)World Bank 1995)



99

1995 Berlin Mandate1995 Berlin Mandate

Negotiate Protocol to quantify Negotiate Protocol to quantify limitations by industrial countries, limitations by industrial countries, e.g. in 2000, 2010, 2020e.g. in 2000, 2010, 2020

Joint implementations pilotJoint implementations pilot Prelude to emissions tradingPrelude to emissions trading



1010

Geneva: June 1996Geneva: June 1996

U.S. Undersecretary of State Tim U.S. Undersecretary of State Tim Wirth proposes my initiative on Wirth proposes my initiative on global emission marketsglobal emission markets



1111

● ● In 1996, the IPCC reported that In 1996, the IPCC reported that human induced emissions of carbon human induced emissions of carbon have a discernible effect on climatehave a discernible effect on climate

● Scientific uncertainty persists● Scientific uncertainty persists

● But it is recognized that the risk of ● But it is recognized that the risk of climate change is real and potentially climate change is real and potentially catastrophiccatastrophic

1996



1212

Kyoto: 1997Kyoto: 1997

166 nations accepted our 166 nations accepted our emissions market proposal to emissions market proposal to UNFCCCUNFCCC

The Kyoto ProtocolThe Kyoto Protocol

The Kyoto ProtocolThe Kyoto Protocol

1997: Kyoto Protocol was signed1997: Kyoto Protocol was signed

Including the Carbon Market – which I Including the Carbon Market – which I wrote into the Kyoto Protocol draftwrote into the Kyoto Protocol draft

But emissions continue to increase But emissions continue to increase outside the KP nationsoutside the KP nations



1313



1414

1998 BUENOS AIRES COP41998 BUENOS AIRES COP4

Set 2 year deadline for completing Set 2 year deadline for completing the KYOTO AGENDAthe KYOTO AGENDA



1515

Kyoto set 5% emission reductions Kyoto set 5% emission reductions for Annex 1 countries by 2008-2012 for Annex 1 countries by 2008-2012 and created three facilitating and created three facilitating mechanisms to achieve thismechanisms to achieve this

The Carbon Market



1616

KP: Facilitating mechanisms for KP: Facilitating mechanisms for Annex 1 countriesAnnex 1 countries

Joint implementation (article 6)Joint implementation (article 6) Emission trading (article 17)Emission trading (article 17)

See also art 3.10 and 3.11See also art 3.10 and 3.11 Clean Development Mechanism Clean Development Mechanism

(CDM)(CDM)



1717

•

Kyoto is the first international Kyoto is the first international agreement based on a market agreement based on a market mechanismmechanismThe Kyoto Protocol sets caps on CO2 The Kyoto Protocol sets caps on CO2 emissions, and allows industrial emissions, and allows industrial nations to trade the rights to emit*nations to trade the rights to emit*

* My proposal for a carbon market, written into the KP

The Carbon Market



1818

Only one mechanism involves both Only one mechanism involves both industrial and developing countries:industrial and developing countries:

CLEAN DEVELOPMENT CLEAN DEVELOPMENT MECHANISMMECHANISM(ARTICLE 12)(ARTICLE 12)



1919

The Kyoto Protocol sets caps on The Kyoto Protocol sets caps on COCO22 emissions, and allows industrial emissions, and allows industrial

nations to trade the rights to emitnations to trade the rights to emit

The Carbon Market becomes The Carbon Market becomes international law in 2005international law in 2005

2005: Kyoto Protocol becomes international law



2020

Kyoto becomes international lawKyoto becomes international law

2005 Kyoto Protocol and its carbon 2005 Kyoto Protocol and its carbon market become International Lawmarket become International Law

2009 Copenhagen COP 15, I 2009 Copenhagen COP 15, I introduce the Green Power Fund and introduce the Green Power Fund and Negative Carbon into the CDMNegative Carbon into the CDM

2011 KP Carbon Market trades $200 2011 KP Carbon Market trades $200 Bn/year*Bn/year*

**The World Bank: “Facts and Trends of the Carbon Market” WB Annual Publication, The World Bank: “Facts and Trends of the Carbon Market” WB Annual Publication,

2011 2011

Global emissionsGlobal emissions

Since 2005 Kyoto Protocol led to Since 2005 Kyoto Protocol led to about 30% reduction in EU about 30% reduction in EU emissions.emissions.

Cf. The World Bank: Facts and Trends of the Carbon Market, 2011Cf. The World Bank: Facts and Trends of the Carbon Market, 2011

But emissions continue to increase But emissions continue to increase outside the Kyoto Protocol nationsoutside the Kyoto Protocol nations



2121



2222

Source: National Oceanic and Atmospheric Administration (NOAA). US Department of Commerce. http://www.noaa.gov/



2323

2007 BALI - COP 13: 2007 BALI - COP 13:

The Bali RoadmapThe Bali Roadmap

2009 COPENHAGEN COP152009 COPENHAGEN COP15

Reducing the U.S. – China impasseReducing the U.S. – China impasse

A NEW COLD WAR?A NEW COLD WAR?

Copenhagen 2009Copenhagen 2009

COP 15 - I introduced COP 15 - I introduced 1.1. The Green Power Fund The Green Power Fund - accepted and - accepted and

announced by Sec of State H. Clinton two announced by Sec of State H. Clinton two days later in Copenhagen days later in Copenhagen

2. Carbon Negative Technologies 2. Carbon Negative Technologies into the CDMinto the CDM

Two seeds with Irresistible Growth*Two seeds with Irresistible Growth**Chichilnisky, G. 2012 *Chichilnisky, G. 2012 The National Journal The National Journal “Two Seeds of Irresistible Growth“Two Seeds of Irresistible Growth””



2424

2011: Durban COP 172011: Durban COP 17

The Green Power Fund is partly The Green Power Fund is partly accepted as the Green Climate Fundaccepted as the Green Climate Fund

Carbon Negative Technologies Carbon Negative Technologies become part of the CDMbecome part of the CDM

What is missing?What is missing?



2525

The Carbon MarketThe Carbon Market

Is now mandatory in 4 continents: EU, Is now mandatory in 4 continents: EU, Asia, Australia and the Americas - in Asia, Australia and the Americas - in Quebec Canada and in California USAQuebec Canada and in California USA

Trading $200 Bn/year in EU ETSTrading $200 Bn/year in EU ETS CDM has transferred over $50Bn for CDM has transferred over $50Bn for

clean tech projects in developing clean tech projects in developing nationsnations

The World Bank: “Facts and Trends of the Carbon Market” annual The World Bank: “Facts and Trends of the Carbon Market” annual report 2005 - 2011 report 2005 - 2011



2626



2727

Policy responsesPolicy responses

The Carbon Market WorksThe Carbon Market Works

The EU ETS Carbon market reduced The EU ETS Carbon market reduced about 30% of EU and Japan’s about 30% of EU and Japan’s emissions since 2005 emissions since 2005

The World Bank The World Bank ‘Facts and Trends of the Carbon Market’ 2011‘Facts and Trends of the Carbon Market’ 2011

2011: “Increased Ambition”2011: “Increased Ambition”

December 2011: Durban South Africa December 2011: Durban South Africa COP 17 extends Kyoto Protocol COP 17 extends Kyoto Protocol mandatory carbon limits until 2015mandatory carbon limits until 2015

COP17 votes to provide a mandate to COP17 votes to provide a mandate to establish global limits by 2020establish global limits by 2020

Durban Platform for Enhanced ActionDurban Platform for Enhanced Action

Columbia Consortium for Risk Columbia Consortium for Risk

Management (CCRM) Management (CCRM) www.columbiariskmanagement.net www.columbiariskmanagement.net

2828



2929

Three outstanding issues for Three outstanding issues for implementation of the Kyoto implementation of the Kyoto

Protocol Protocol

Opposition from the private sectorOpposition from the private sector

Developing countries do not participate in Developing countries do not participate in emissions limitsemissions limits

U.S.-China impasse: A new Cold War?U.S.-China impasse: A new Cold War?



3030

All three issues arise from All three issues arise from fears that emissions limits will fears that emissions limits will interfere with economic growth interfere with economic growth and the rise in standards of and the rise in standards of livingliving

Critical for all nations Critical for all nations especially for developing especially for developing countriescountries



3131

How to cut the link between How to cut the link between emissions and economic emissions and economic growth?growth?

Only new clean technologies can Only new clean technologies can achieve thisachieve thisThe carbon market is the solutionThe carbon market is the solutionIt introduces a price for carbon and It introduces a price for carbon and makes clean technology profitable, makes clean technology profitable, and fossil fuels expensive and and fossil fuels expensive and undesirableundesirable

How the Carbon Market and its Green How the Carbon Market and its Green Power Fund Overcomes these IssuesPower Fund Overcomes these Issues

Green Power Fund – a $200 Bn/year Green Power Fund – a $200 Bn/year private public fund private public fund

Funded by Carbon Market – which already Funded by Carbon Market – which already trades $200 Bn/yeartrades $200 Bn/year

Funding to provide off takes to build Funding to provide off takes to build carbon negative power plants in LA, Africa carbon negative power plants in LA, Africa and AOSISand AOSIS

This is the ONLY WAY the CDM can bring This is the ONLY WAY the CDM can bring funding to these three regions – why?funding to these three regions – why?



3232



3333

New technology requires New technology requires appropriate economic appropriate economic

conditions to be conditions to be implemented. implemented.

Resource prices are keyResource prices are key

The Carbon Market Changes the Global Economy



3434

Prices have an impactPrices have an impact A much-quoted statistic on this subject is A much-quoted statistic on this subject is

that the amount of energy used in that the amount of energy used in producing $1000-worth of constant-dollar producing $1000-worth of constant-dollar GNP in the USA fell by 38.9% from 1973 to GNP in the USA fell by 38.9% from 1973 to 1983. 1983.

This was a result of switching to more This was a result of switching to more energy-efficient technologies, and mostly of energy-efficient technologies, and mostly of demand patterns changing away from demand patterns changing away from energy intensive products and services. energy intensive products and services. Most of this striking drop in energy use Most of this striking drop in energy use occurred in the period 1979-1983.occurred in the period 1979-1983.



3535

New TechnologiesNew Technologies(fuel cells, solar)(fuel cells, solar)

seem uncompetitive because of seem uncompetitive because of excessively low resource pricesexcessively low resource pricesand a $400 Bn/year subsidies to and a $400 Bn/year subsidies to

the coal industrythe coal industry

In real terms, oil prices are still In real terms, oil prices are still relatively lowrelatively low



3636

Through clean technologies, Through clean technologies, developing countries can developing countries can

“leapfrog”, without repeating the “leapfrog”, without repeating the resource-intensive growth that resource-intensive growth that

characterizes industrial characterizes industrial countriescountries



3737

Technology transfers and Technology transfers and emissions tradingemissions trading

Today there is no incentive for a USA Today there is no incentive for a USA corporation to set plants in corporation to set plants in

developing countries using modern, developing countries using modern, clean technologyclean technology



3838

Carbon MARKETSCarbon MARKETS

Change all thisChange all thisThey reward the transfers of clean They reward the transfers of clean

technologytechnology

How?How?



3939

Before the Carbon MarketBefore the Carbon Market

The profits obtained by a firm are the The profits obtained by a firm are the same for a Ford factory that same for a Ford factory that produces car parts in China using produces car parts in China using dirtydirty technology or technology or clean clean technologytechnology



4040

If Ford is allocated carbon If Ford is allocated carbon credits for clean car technology credits for clean car technology corresponding to the emissions corresponding to the emissions saved, it can cash these permits saved, it can cash these permits

in the emissions marketin the emissions market

After the Carbon Market



4141

Carbon MarketCarbon Market for Emission Credits for Emission Credits

In the KP Annex 1 Countries were In the KP Annex 1 Countries were given allocations of property given allocations of property

rights on emissions summing up rights on emissions summing up to a 5% reduction from 1995 to a 5% reduction from 1995

global emissions, and they can global emissions, and they can trade these freely among trade these freely among

themselvesthemselves

REDDREDD

A proposal to provide carbon credits for A proposal to provide carbon credits for “Reducing Emissions from Deforestation and “Reducing Emissions from Deforestation and forest Degradation”forest Degradation”

Not accepted by UNFCC because of low Not accepted by UNFCC because of low effectiveness. Recent IPCC Canadian study effectiveness. Recent IPCC Canadian study showed that forests are too slow as sinks of CO2: showed that forests are too slow as sinks of CO2: If every square ft of arable land in the planet was If every square ft of arable land in the planet was planted, it would not absorb more than 10% of planted, it would not absorb more than 10% of CO2 that humans emit by the end of the 21CO2 that humans emit by the end of the 21stst century.century.



4242

Yasuni Initiative*Yasuni Initiative* President Correa of Ecuador requests compensation from President Correa of Ecuador requests compensation from

the international community for not cutting down their part the international community for not cutting down their part of the Amazon forest to explore and extract petroleumof the Amazon forest to explore and extract petroleum

60% of Ecuador’s population is indigenous and has opposed 60% of Ecuador’s population is indigenous and has opposed for many years the use of Ecuador’s forests by international for many years the use of Ecuador’s forests by international oil companiesoil companies

60% of Ecuador’s export revenues are from petroleum60% of Ecuador’s export revenues are from petroleum

**The Economics of the Yasuni InitiativeThe Economics of the Yasuni Initiative, Joseph Henry Vogel, foreword by G. Chichilnisky, Anthem Press, 2009



4343



4444

OTHER EXAMPLESOTHER EXAMPLESof Environmental Markets*of Environmental Markets*

The trading of SOThe trading of SO22 in the Chicago in the Chicago Board of Trade since 1993, following Board of Trade since 1993, following the Clean Air Act – successfully and the Clean Air Act – successfully and effficiently eradicated acid rain in the effficiently eradicated acid rain in the US in 20 yearsUS in 20 years

Water Markets in Australia and Water Markets in Australia and CaliforniaCalifornia

**Environmental Markets: Equity and EfficiencyEnvironmental Markets: Equity and Efficiency, Chichilnisky and Heal 2000, Chichilnisky and Heal 2000



4545

Biodiversity and Markets for Biodiversity and Markets for emissions permitsemissions permits

Deforestation is the source of Deforestation is the source of approximately 20% of global approximately 20% of global greenhouse gas emissions. Science greenhouse gas emissions. Science has shown that forests act as “sinks” has shown that forests act as “sinks” retaining large amounts of carbon retaining large amounts of carbon and absorbing large quantities of and absorbing large quantities of carbon dioxidecarbon dioxide



4646

The watershed problem is globalThe watershed problem is global

The value of watershed services to The value of watershed services to major cities across the world is major cities across the world is estimated at $900 billion*estimated at $900 billion*

One can securitize watershed services One can securitize watershed services through innovative financial through innovative financial instrumentsinstruments

* cf. G. Chichilnisky and G. Heal * cf. G. Chichilnisky and G. Heal NatureNature 1995 1995



4747

SECURITIZATIONSECURITIZATION

Form corporation to manage Form corporation to manage conservationconservation

Corporation owns the cost savings Corporation owns the cost savings from conserving watershedfrom conserving watershed

Finance conservation by selling Finance conservation by selling sharesshares

Local community and state should Local community and state should own sharesown shares



4848

Increased knowledge can helpIncreased knowledge can helpHow?How?

It can lead to:It can lead to:

Better understanding of natural risks and Better understanding of natural risks and how to manage them (El how to manage them (El Nino and Catastrophe Bundles)Nino and Catastrophe Bundles)

Better understanding of human impacts on Better understanding of human impacts on nature and of new courses of action nature and of new courses of action (watersheds and environmental (watersheds and environmental bonds)bonds)



4949

Markets are widely used Markets are widely used institutionsinstitutions

They are decentralized, and can be efficient.They are decentralized, and can be efficient.But global environmental markets trade But global environmental markets trade unusual goods: unusual goods: privately produced public privately produced public goodsgoods

● Biodiversity is one● Biodiversity is one● The planet’s atmosphere is another● The planet’s atmosphere is another



5050

Environmental assets are often Environmental assets are often public goodspublic goods

COCO22 concentration in the atmosphere concentration in the atmosphere is a quintessential public good is a quintessential public good because it mixes very thoroughly because it mixes very thoroughly throughout the planet and is very throughout the planet and is very stable (remains about 100 years)stable (remains about 100 years)

It is not a typical public good It is not a typical public good because it is not produced by the because it is not produced by the government such as defensegovernment such as defense

COCO22 is privately produced is privately produced



5151

Public goods change Public goods change mattersmatters

New Economic FindingsNew Economic Findings Only certain allocations of property Only certain allocations of property

rights on the atmosphere between rights on the atmosphere between countries will yield efficient market countries will yield efficient market solutionssolutions

This ties together the goals of This ties together the goals of efficiency and fairness:efficiency and fairness:

The aspirations of North and SouthThe aspirations of North and South



5252

Privately produced public goodsPrivately produced public goods

are goods which are not “rival” in are goods which are not “rival” in consumption, but are privately consumption, but are privately producedproduced

we all produce emissions but the we all produce emissions but the atmosphere is the same for us allatmosphere is the same for us all



5353

First Theorem of Welfare EconomicsFirst Theorem of Welfare Economics

The allocation resulting from a competitive The allocation resulting from a competitive market equilibrium with private goods is market equilibrium with private goods is Pareto efficient (Arrow, 1950)Pareto efficient (Arrow, 1950)

This theorem is independent of the This theorem is independent of the distribution of property rights. For distribution of property rights. For example: all but two traders may have example: all but two traders may have zero endowments of property rights and zero endowments of property rights and the resulting equilibrium is still Pareto the resulting equilibrium is still Pareto efficient.efficient.



5454

• But it requires all traded But it requires all traded goods to be goods to be private private

goods, goods, with rival with rival consumption, and privately consumption, and privately

owned.owned.



5555

Markets with PPP goods are Markets with PPP goods are different from standard marketsdifferent from standard markets

In private goods markets, In private goods markets, efficiency and fairness are efficiency and fairness are separate concepts (often called separate concepts (often called Coase’s theorem)Coase’s theorem)

In markets with privately produced In markets with privately produced public (PPP) goods these two public (PPP) goods these two concepts are linkedconcepts are linked



5656

With private goods efficiency requires With private goods efficiency requires that MRS=MRT, but with public goods that MRS=MRT, but with public goods

the formula changes:the formula changes:

Lindahl-Bowen and Samuelson proved Lindahl-Bowen and Samuelson proved that:that:

Sum of MRS across people = MRTSum of MRS across people = MRT



5757

● ● For efficient markets, traders For efficient markets, traders should choose freely between should choose freely between private goods and private goods and environmental qualityenvironmental quality

● ● However the atmosphere However the atmosphere concentration of COconcentration of CO22 is one and is one and the same for all. This is an the same for all. This is an unavoidable physical factunavoidable physical fact



5858

● ● Therefore free choice must Therefore free choice must lead every trader to select the lead every trader to select the same overall trade-off between same overall trade-off between private goods and atmospheric private goods and atmospheric qualityquality

● ● For this to happen, trader’s For this to happen, trader’s wealth should not be too far wealth should not be too far apartapart



5959

● ● Efficiency and distribution are Efficiency and distribution are connected in markets with PPP connected in markets with PPP goodsgoods

● ● A measure of equity is A measure of equity is necessary for efficiencynecessary for efficiency

● ● Markets with knowledge and Markets with knowledge and environmental assets require environmental assets require equity for efficiencyequity for efficiency



6060

First Welfare Theorem in First Welfare Theorem in Markets with Privately Markets with Privately

Produced Public GoodsProduced Public Goods

Only a finite number of ways of Only a finite number of ways of distributing property rights on a distributing property rights on a given total of emissions rights given total of emissions rights between the traders gives rise to between the traders gives rise to efficient market allocations*efficient market allocations*

*Chichilnisky, Heal and Starrett 2000*Chichilnisky, Heal and Starrett 2000



6161

● ● Efficiency and distribution are Efficiency and distribution are closely connected in economies closely connected in economies with environmental assetswith environmental assets

● A measure of equity is ● A measure of equity is necessary for efficiencynecessary for efficiency



6262

POLICYPOLICY

Those who have fewer endowments Those who have fewer endowments of private goods must be endowed of private goods must be endowed with more property rights on the use with more property rights on the use of the PPP good. Otherwise the of the PPP good. Otherwise the market does not operate efficientlymarket does not operate efficiently



6363

● ● One way to ensure this is to follow a One way to ensure this is to follow a simple rule: the countries that emit less simple rule: the countries that emit less receive somewhat more permits:receive somewhat more permits:

● A “reverse grand-fathering” allocation● A “reverse grand-fathering” allocation

● Repeated across time, such a policy ● Repeated across time, such a policy would compensate those who use the would compensate those who use the atmosphere judiciously and provide atmosphere judiciously and provide incentives to abateincentives to abate



6464

This scheme:This scheme:

Rewards the transfers of clean Rewards the transfers of clean technology to developing countriestechnology to developing countries

Multiplies the returns on R&D in the Multiplies the returns on R&D in the private sectorprivate sector

Securitizing these returns attracts Securitizing these returns attracts global capital from private sources global capital from private sources for clean technology transfersfor clean technology transfers



6565

A market hasA market has NN traded goods andtraded goods and HH traderstraders

Each trader has a preferenceEach trader has a preference uuhh : R : RNN R R

andand an allocation of property rightsan allocation of property rights

ΩΩhh Є Є RRNN..

NEW MARKETS



6666

What is economic efficiency:What is economic efficiency:

A feasible allocation is A feasible allocation is Pareto Pareto efficient efficient if there is no other feasible if there is no other feasible allocation which makes everybody as allocation which makes everybody as well off, and some strictly better offwell off, and some strictly better off



6767

A A competitive equilibrium competitive equilibrium is a priceis a price p* p* RRN N and an allocationand an allocation xx11,…,x,…,xHH RRN x HN x H such that such that each trader maximizes utility subject to a each trader maximizes utility subject to a budget constraint:budget constraint:

Max uh(y) where y {z Є RN : <p*, z> = <p*,Ωh>}

And markets clear:And markets clear:

Σ xh = Σ Ωh.

H H

h=1 h=1



6868

A competitive market equilibriumA competitive market equilibrium

Is a set of pricesIs a set of prices p*p* and an allocation of and an allocation of goods goods xx11,…, x,…, xHH RRN x H N x H at which each trader at which each trader maximizes utility subject to a budget maximizes utility subject to a budget constraint, and all markets clear.constraint, and all markets clear.



6969

A General ModelA General Model

•Consider a world economy with I countries, I ≥ 2 , indexed by i = 1,…,I. Each has a utility function ui , arguments a vector of private goods ci = (ci,1,ci,2,…,ci,m) where m is the number of private goods, and also the quality of the world’s atmosphere, a, which is a public good.

• The quality of the atmosphere, a, is measured by the reciprocal or the negative of CO2 concentration. The concentration of CO2 is “produced” by emissions of carbon, which are positively associated with the production of private goods.



7070

•Let y be a vector giving the production levels of the m private goods in the country i

a = Σ ai , ai = Φ (yi) and < 0 i.

a is a measure of atmospheric quality overall, and ai is an index of the abatement carried out by country i.

•Feasibility is defined by the above and by the condition that the total consumption of each private good worldwide equal total production:

ci = yi

This allows unrestricted lump sum redistributions.

I

i=1

yi,l

i=1,…,I i=1,…,I



7171

A Pareto efficient allocation is the solution to the problem of A Pareto efficient allocation is the solution to the problem of maximizing the utility of a designed country, subject to the maximizing the utility of a designed country, subject to the other countries all reaching prescribed utility levels. This other countries all reaching prescribed utility levels. This gives the following conditions: gives the following conditions:

= λ= λkk l = l = 1,…,1,…,mm and and k k i.i.

This implies common MRS for all countries. Country This implies common MRS for all countries. Country ii is the is the

country whose utility is being maximized, and λcountry whose utility is being maximized, and λkk is a is a Lagrange multiplier associated with the constraint that Lagrange multiplier associated with the constraint that country country kk reach a specified welfare level, and reach a specified welfare level, and

= = l ,l ,

ui

ci,l

uk

ci,l

i

yi,l

uk

ci,l

k kuk

a



7272

First Welfare Theorem for Markets with First Welfare Theorem for Markets with Privately Produced Public GoodsPrivately Produced Public Goods

TheoremTheorem

In an economy with In an economy with kk2 traders, 2 traders, jj1private 1private goods and a public good, there exists at most a goods and a public good, there exists at most a

one-dimensional manifold o property rights one-dimensional manifold o property rights allocations on the use of the public good allocations on the use of the public good (allocation of “permits”) from which the (allocation of “permits”) from which the

competitive equilibrium is Pareto efficient.competitive equilibrium is Pareto efficient.

This is the Manifold of Efficient Allocations of This is the Manifold of Efficient Allocations of

Property RightsProperty Rights



7373

First Welfare TheoremFirst Welfare Theorem

In Markets with Privately Produced Public GoodsIn Markets with Privately Produced Public Goods There is only a finite number of ways of There is only a finite number of ways of

distributing property rights on a given total distributing property rights on a given total environmental use between the traders so that environmental use between the traders so that the the market equilibrium is Pareto efficientmarket equilibrium is Pareto efficient

Typically efficiency requires that those with fewer Typically efficiency requires that those with fewer endowments of private goods should have a endowments of private goods should have a higher allocation of property rights on the public higher allocation of property rights on the public goodsgoods

Chichilnisky, 1992-3Chichilnisky, 1992-3Chichilnisky and Heal, 1993Chichilnisky and Heal, 1993Chichilnisky, Heal and Starrett, 1993-4Chichilnisky, Heal and Starrett, 1993-4



7474

Simple Example of a Market with Simple Example of a Market with Privately Produced Public GoodsPrivately Produced Public Goods

Two Countries, i=1,2Two Countries, i=1,2

Two Goods: Two Goods:

one private: one private: xx one public: one public: aa = abatement = - emissions = abatement = - emissions

Initial data: Initial data: (1) technology (1) technology aax,x, and(2) property rights on the use of the public good,(2) property rights on the use of the public good,

aai i , , i=1,2 i=1,2 aaii = a = a



7575

Each Country solves the following problem:Each Country solves the following problem:

((**)) Max u Max ui i (x(xi i ,a),,a),

Such thatSuch that

xxi i = = aaii( a( aii – a – aii), ), ’ ’

where where is the market price of is the market price of xx relative to relative to a , a , namely the “permit” price

At a World Market Equilibrium each country maximizes utility At a World Market Equilibrium each country maximizes utility (*),(*), and all markets clear and all markets clear

aaii = = aaii = a = a

ii



7676

2 nations market equilibrium trading a private and a public good



7777

New Economic FindingsNew Economic Findings

Efficiency in trading permits requires Efficiency in trading permits requires more emission rights to developing more emission rights to developing countriescountries

Why?Why?



7878

Market Equilibrium: two nations trading two goods – one private and one public



7979

Experiments withExperiments withGREEN MODELGREEN MODEL

Show that the world cost Show that the world cost of abatement is lower of abatement is lower when the South is given when the South is given proportionately more proportionately more permitspermits



8080

Experiments with Columbia-Green Experiments with Columbia-Green model:model:

General equilibrium model with General equilibrium model with permit marketspermit markets

12 regions12 regions 12 by 12 international trade matrix12 by 12 international trade matrix 8 sectors8 sectors Experiments lead to similar finding, Experiments lead to similar finding,

i.e. equity and efficiency are i.e. equity and efficiency are connectedconnected



8181

Sensitivity analysis of the OECD-Sensitivity analysis of the OECD-PIR global model shows that it is PIR global model shows that it is more efficient to allocate somewhat more efficient to allocate somewhat more permits to developing more permits to developing countriescountries Currently the N-S per capita difference in Currently the N-S per capita difference in

emissions is 6:1emissions is 6:1 IN the case of U.S. the difference is 10:1IN the case of U.S. the difference is 10:1 Developing countries with more than 86% Developing countries with more than 86%

of the world population emit less than 70% of the world population emit less than 70% of the total carbon emissionsof the total carbon emissions



8282



8383



8484



8585



8686



8787



8888

Present Value of Real Income Loss over 2000-2050Present Value of Real Income Loss over 2000-2050(in percentage deviation relative to BaU)(in percentage deviation relative to BaU)

INDIVIDUALINDIVIDUAL

STABLILITYSTABLILITYUNIFORMUNIFORM

TAXTAXGRANDGRAND

FATHERINGFATHERINGPOPULATION POPULATION

BASEDBASEDMIXEDMIXED

USAUSA

JPNJPN-O.79-O.79

-2.41-2.41-0.90-0.90

-1.24-1.24-0.76-0.76

-1.83-1.83-2.94-2.94

-2.84-2.84-1.84-1.84

-2.34-2.34

EECEEC

OOEOOE-1.23-1.23

-0.58-0.58-1.16-1.16

-0.55-0.55-1.22-1.22

-0.54-0.54-3.13-3.13

-1.53-1.53-2.19-2.19

-1.04-1.04

EEXEEX

CHNCHN-3.39-3.39

-3.88-3.88-0.83-0.83

-3.47-3.47-0.78-0.78

-4.14-4.14 0.090.09

6.026.02-0.39-0.39

1.041.04

FSUFSU

INDIND-1.42-1.42

-2.61-2.61-2.66-2.66

-2.00-2.00 1.081.08

-2.94-2.94-7.13-7.13

14.6214.62-2.92-2.92

7.007.00

EETEET

DAEDAE-0.33-0.33

-0.29-0.29-1.09-1.09

0.160.16 0.810.81

0.200.20-5.94-5.94

0.190.19-2.51-2.51

-0.05-0.05

BRABRA

ROWROW-1.60-1.60

-0.40-0.40-1.78-1.78

-0.01-0.01-4.40-4.40

0.050.05-0.55-0.55

0.210.21-2.45-2.45

0.120.12

WORLDWORLD -1.65-1.65 -1.16-1.16 -1.17-1.17 -1.06-1.06 -1.07-1.07



8989

This is because each dollar of This is because each dollar of investment yields more output in investment yields more output in

the Souththe South



9090



9191



9292



9393

TODAYTODAY

There is a general agreement that There is a general agreement that making accessible more making accessible more development funding for poor development funding for poor countries in a controlled and countries in a controlled and incremental fashion could benefit the incremental fashion could benefit the world economy as a wholeworld economy as a whole



9494

TODAYTODAY

There is a general agreement that There is a general agreement that something must be done at the something must be done at the international levelinternational level

Kyoto, December 1997 COP was a Kyoto, December 1997 COP was a turning pointturning point



9595

Yet in the global negotiations, the Yet in the global negotiations, the division between industrial and division between industrial and developing nations is as deep as everdeveloping nations is as deep as ever

There is a general agreement that There is a general agreement that without bridging North-South gap there without bridging North-South gap there will be no real progresswill be no real progress

How to move ahead?How to move ahead?



9696

One way to ensure this is to follow a One way to ensure this is to follow a simple rule: the countries that emit simple rule: the countries that emit less receive somewhat more permits:less receive somewhat more permits:

A “reverse grand-fathering”allocationA “reverse grand-fathering”allocation

Repeated across time, such a policy Repeated across time, such a policy would compensate those who use the would compensate those who use the atmosphere judiciously and provide atmosphere judiciously and provide incentives to abateincentives to abate



9797

The Key IssuesThe Key Issues•Allocation of rights on the use of the atmosphere

•This is a question of efficiency as well as equity

More on this in the next lectures



9898

How to resolve How to resolve the China-US Impassethe China-US Impasse

• New Financial Mechanisms: Bilateral Options (Chichilnisky: Time Magazine 2010)

•Carbon Negative Technologies



9999

Technology TransferTechnology Transfer

•Negative Carbon Market •To increase clean energy

• Reduce carbon in the atmosphere



100100

New Financial Mechanisms:New Financial Mechanisms:Bilateral Options Bilateral Options

the Green Power Fundthe Green Power Fund• •Based on Carbon Market • Replicating Article 4 of UNFCCC

• North and South get what each wants

Resolving the Global Resolving the Global Environmental CrisisEnvironmental Crisis

The following lectures develop The following lectures develop

solutionssolutions



101101

Pegram Lecture 2, August 10, 2012

Technology

Transcript of Pegram Lecture 2, August 10, 2012