Economics of climate change

The purpose of the paper is to discuss the ineffectiveness of 1992 UNFCCC (UNFCCC 1992) in protecting the global climate. Despite expectations of many concerned citizens, the convention has not reverted the global trend of rising greenhouse gas (mainly carbon dioxide) emission. Its failure has been caused by the fact that it allows most of the signatories to increase their emissions without any constraints. Some (modest) constraints are imposed only on emitters where the emission does not have a strong growth potential. In economics language, the failure is caused by the fact that the convention ignores some basic ‘public good’ characteristics of the global climate.

Climate change poses one of the most difficult economic questions. The problem has been virtually solved by natural scientists. Climate is a very complex issue. It underwent drastic changes many times in the past. Yet its present dynamics seems to be unprecedented. No competent natural scientist would dare to foretell its future, of course. Nevertheless contemporary climatology allows to build partial differential equations that describe such variables like temperature, humidity, chemical composition of the air and so on quite accurately. In order to predict something, the entire planet has to be characterized by millions of these equations. Finding solutions to such systems of millions of equations that depend on each other is a formidable task. Very few teams – consisting of top global climatologists and top computer scientists – can meet this challenge. In the 1990s, there were only 12 simulation models to trace global temperature changes. Of these, 8 predicted global warming, and 4 did not. Now the number of models is somewhat larger, but the simulations still pose a challenge (IPCC 2007).

This does not imply that the global warming issue has not been resolved yet. Almost all scientists who can understand these models confirm the adequacy of those that predict the global warming, and explain why the others fail. The problem is not considered controversial anymore by them. Controversies are voiced by those who are not competent to analyse it scientifically.

The consensus with respect to the problem whether climate change is real does not imply a consensus with respect to the problem of how to address it. There are significant differences in opinions on how to solve it effectively. The often acknowledged fact that the cost of preventive measures is lower than the cost of damages resulting from climate change for the entire planet is not relevant (Tol, 2014). International environmental cooperation requires that sovereign countries are motivated to accept specific measures voluntarily (Żylicz, 2015). If there were a global government to take decisions in order to improve the global welfare, finding benefits to be higher than costs would be sufficient to implement measures required. Yet a global government does not exist. Hence, international agreements are usually taken on if the signatories bear the cost, which is justified by the benefits of their individual actions rather than actions of other signatories. This is the curse of the so-called public goods, which have been researched in economics for quite a while.

The definition of a public good refers to two principles: non-rivalry and non-exclusion. The first means that if a good has been provided then nobody can be excluded from using it. The second one states that the same unit of a good can be simultaneously enjoyed by many users. These principles give incentives for potential users to ‘free ride’. Nobody wants to finance the provision of such a good; everybody waits until the good is provided by somebody else knowing that no potential beneficiaries can be excluded. As a result, the good is not provided at all, or it is ‘underprovided’, that is, its available quantity is lower than justified by the sum of benefits enjoyed by all beneficiaries (not only by those who contributed to its provision).

Global climate protection serves as a textbook example of a public good. If it succeeds, then all will benefit from it – also those who did not contribute to it. At the same time, those who did exert some effort are not guaranteed to enjoy benefits expected; the lack of expected benefits can result from inaction of those who do not undertake an effort (or undertake it to an insufficient degree). A struggle to protect the global climate over the last decades illustrates the point.

The rest of the paper is organised as follows. The next section analyses the 1995 Berlin Mandate. Section 3 characterises the 2015 Paris Agreement. This is followed by an analysis of forestry. Section 5 summarises the paper.

United Nations Framework Convention on Climate Change (UNFCCC) was signed in 1992. In its articles 3 and 4, it introduced the famous concept of Common But Differentiated Responsibility (CBDR). The phrase ‘common but differentiated responsibilities’ was referred to in art. 4 par. 1 as well.

The concept is fairly obvious, since every state should feel responsible for the climate, while it certainly means something different for Sierra Leone, and something different for Brazil. Later on, in the Berlin Mandate of 1995 (Berlin Mandate 1995), the responsibility was limited to ‘developed economies’. This unfortunate interpretation referred to countries that were classified as ‘developed’ by the United Nations in the 1970s. As a result, Bulgaria is considered ‘developed’, while South Korea is not.

This idea was implemented two years later, at the third conference of the UNFCCC signatories. The famous Kyoto Protocol of 1997 (Kyoto Protocol 1997) confirmed the division of the world into Annex I (the ‘rich’) and the rest of the world (the ‘poor’). Only the former were required to take commitments to reduce carbon dioxide emission. The latter were not obliged to reduce their emissions. The outcome of such an arrangement was easy to predict. In 1995–2017, the global emission of carbon dioxide grew by roughly 40% (from 25 billion tons to 35 billion tons). The European Bank of Reconstruction and Development, EBRD (EBRD 2011) estimated that the global emission grew by 0.61% annually prior to signing the UNFCCC. Later on, it accelerated to 1.24%, and reached 2.61% after the Kyoto Protocol. The increased pace does not imply that documents like the UNFCCC and the Kyoto Protocol caused it, but it demonstrates that the agreements were not effective in solving the climate change problem.

Failing attempts to solve the global climate do not surprise those who see the problem as a predicament of a public good, which cannot be addressed effectively through unilateral actions. Reducing emissions in developed economies – even down to zero – will not result in reducing global emission. On the contrary, the more is reduced in developed economies, the more is emitted elsewhere. So-called carbon leakage (analysed by economists extensively [Kiuila et al., 2016]) is responsible for the paradox.

There are three types of carbon leakage. First of all, it can be linked to relocating production. If emission constraints are introduced in one region, then production can move to a region without such constraints. This is a clear, straightforward mechanism. Nevertheless, it has been observed in practice very rarely. Alternatively carbon leakage can be linked to relocating investments. A capital owner who wants to invest his money, has a choice to do it in a country committed to emission reductions or somewhere else. Very often, he obviously chooses to do it elsewhere, thus relocating future emission to a country that has no emission reduction commitments. Finally, carbon leakage can be linked to raw material markets. If a country committed to emission reduction eliminates raw materials causing especially heavy emissions (e.g., fossil fuels), global demand for these materials goes down. This leads to their falling prices thus making them more attractive in countries that do not have similar commitments. This is the so-called green paradox, which has been often observed, and widely analysed in the economic literature (e.g., Felder and Rutherford, 1993; Sinn, 2008). The spectacular and sustained growth in the global carbon dioxide emission can be linked – at least in part – to the Berlin Mandate causing the carbon leakage.

There were numerous attempts to abandon the Berlin Mandate, and encourage non-Annex I countries to accept some commitments. As a rule, they were refuted by pointing at the CBDR principle. Non-Annex I countries referred to the 19th century heritage and especially to their colonial past. At the same time, some Annex I countries proclaimed the ideology of ‘providing a good example’ (as if the others were to be overwhelmed by this example and were to reduce emission voluntarily). Numerous experts hoped to have unilateral reductions in rich countries resulted in fast technological progress driving the cost of ‘low carbon’ technologies down to make these attractive for poor countries expected to abandon fossil fuels and to decrease their carbon dioxide emissions spontaneously without any obligations.

Affirmation of the Berlin Mandate is irrational. Indeed, industrialized countries developed in the 19th century jauntily, and they emitted carbon dioxide that contaminates the atmosphere until now. Hence, their responsibility for climate change is unquestionable. However, if one looks at the cumulative emission (starting from the 19th century until the present), then it turns out that all three important regions – Europe, North America and China – have almost identical contributions of 16–17%. The entire 19th century emission from England is smaller than the Chinese emission of the last couple of years (since 2007, China has been the world's largest carbon dioxide emitter); CBDR is important, but it implies something different from what many people deem. Providing a good example is a wonderful method of raising children, but it fails completely as a negotiation strategy with partners who are rational rather than childish. Hopes to make low carbon technologies cheap proved premature too. Thus the only chance to protect the global climate requires that all countries take commitments to reduce emissions.

The 2015 Paris Agreement (Paris Agreement 2015) has been historic, since for the first time, non-Annex I countries took some commitments (called Intended Nationally Determined Contributions, INDC [INDC 2017]). These commitments are far from satisfactory; some of them sound even insincere. For instance, the Chinese government declares that in the 2030s, the emission will be stabilized. Or it declares that emission per unit of GDP will be lower (given the fact that the GDP will grow, the absolute emission may keep growing anyway). The government of Mexico declares that deforestation will be stopped by 2030 (in other words, it anticipates that deforestation will continue until 2030). Nevertheless, when compared to the first two decades of UNFCCC, for the first time, there is some hope for future improvements.

A key for the Paris Agreement to succeed is to implement a mechanism to increase the ambition level of INDCs. Many declared activities are not ambitious, because governments are afraid of excessive costs. Demonstrating that these costs are not doomed to be excessive may serve as an encouragement for governments to declare more ambitious targets. Two decades ago, some experts believed that the so-called Clean Development Mechanism (CDM) could do the job. The mechanism boiled down to a system that an Annex I country pays for a project to decrease carbon dioxide emission in a non-Annex I country, and thus, ‘acquires’ the right to avoid a corresponding emission reduction it was committed to. This is a very imperfect mechanism, since the emission reductions caused by CDM projects (implemented in countries which do not have binding emission baselines) can be arbitrary. Proponents of the CDM idea were surprised by the fact that – despite carrying out a great number of reasonable CDM projects – the global carbon dioxide emission grows even faster.

Article 6 of the Paris Agreement outlines a somewhat different mechanism to encourage governments to adopt more ambitious INDCs. At the moment, they hesitate to increase the ambition level, since costs seem to be excessive. The idea is thus to demonstrate that a country facing very expensive abatement options could pay for a corresponding abatement elsewhere (where cheaper options are available). Alternatively, if a country where these cheaper options are available could ‘sell’ them to a wealthier country (i.e., could finance some of its projects externally), international community would get a chance for a more effective climate protection. Article 6 of the Paris Agreement should facilitate this.

If a country finds the abatement of carbon dioxide very costly, it may happen that some other country finds it much cheaper. From the point of view of climate protection, it does not matter which country did what, since carbon dioxide mixes in the atmosphere quickly and thoroughly. Therefore, if an emitter can ‘buy’ a cheaper reduction somewhere else, it will not complain about excessive costs. This is precisely what the Paris Agreement regulates in its Article 6. The official name of such a transaction reads ‘internationally transferred mitigation outcomes to achieve nationally determined contributions’.

The wording of Article 6 is extensive and complicated. It is more than a page long, and consists of nine items. It reflects prejudices of delegates who insisted on introducing some specific political ideas. It avoids the term ‘market solutions’. At the same time, it includes (several times) the term ‘non-market approach’, whatever it means.

Four aspects of the Article 6 are essential: first, the legal status of INDCs; second, creating their inventories; third, verification system; fourth, independence of control institutions. All of them are included there. An important question is whether any commitments regulated by this article are compulsory. Strictly speaking, they are not, since – as the name indicates – INDCs are adopted voluntarily. However, when a country (voluntarily) adopts an INDC, this becomes binding and it can be used as a base for allocating specific tasks of reducing emissions by economic agents. Such tasks can become objects of international trade. Institutional independence is guaranteed by all signatories (not only by those who take part in a bilateral exchange). It is crucial that the verification system does not confine to parties to an exchange (the buyer and the seller), who are not necessarily interested in a detailed scrutiny, but it includes all parties to the Paris Agreement.

Article 6 states that an international transaction cannot include emission reductions achieved against objectives of sustainable development. It is not entirely clear what this principle implies but it will certainly exclude some kinds of projects. For instance, if a country managed to reduce carbon dioxide emission by improving the efficiency of an existing traditional power plant, the investment was not a breakthrough in leaving behind fossil fuel technology. Yet such a breakthrough would be necessary if the country were to abandon the traditional development philosophy. Article 6 includes two items that may hinder international cooperation: 6.4(d) and 6.6. The first requires that the global emission must decrease as a result of every transaction. The second mandates that every transaction must provide some money to be spent on the poorest countries. Both principles can be applied in a reasonable manner, but – on the other hand – they can prohibit transactions totally. Examples below explain what a ‘reasonable’ application of 6.4(d) and 6.6 is.

The objective of 6.4(d) can be understood strategically, as an incentive for signatories to increase their level of ambition and ultimately to lower the emission. All transactions serve as a means to this end. On the other hand, it can be understood formally, as a rule that every single transaction must imply a lower global emission immediately. Thus, reducing the emission in one country by 1 million ton allows some other country to decrease its reduction target by a somewhat lower quantity. Everything depends on the interpretation of the ‘somewhat lower’. If the ‘somewhat lower’ means something small, the transaction will take place probably. However, if it is meant as something substantial, then emitters who do the abatement are not likely to find buyers of their (drastically depreciated) reductions. In the 1970s, American firms faced such an obstacle when emission trading was slowed down by an excessive expectation of the total emission decrease. One can be afraid that some signatories of the Paris Agreement will insist on a formal rather than strategic interpretation of 6.4(d).

The principle included in 6.6 is quite understandable: ‘let the rich pay for the poor’. Its problematic consequences can be explained by a numerical example. Let us assume that the country A has an opportunity to reduce carbon dioxide emission by 1 million tons at the cost of €8,000,000. In country B, the same reduction costs €10,000,000. If the country B offers the country A to pay €9,000,000 for the reduction, the transaction will be profitable for both (each party will gain €1,000,000: A by selling its reduction, B by avoiding to undertake abatement it was committed to). Item 6.6. states that a part of this transaction is to be donated for the poorest ones. If this part was specified as, say, 6% – then the €9,000,000 transaction would imply the donation of €540,000. Each party could pay €270,000 and still enjoy a net gain of €730,000 (1,000,000–270,000 = 730,000). However, if this part was specified as, say, 30% – then the same transaction would imply the donation of €2,700,000. Even if both parties allocated their entire gains for this purpose, a deficit would show up. Irrespective of the price agreed, which must have been set at some level between €8,000,000 and €10,000,000, the transaction could not be carried out. Both parties would lose, but the poorest would turn out to be losers too, since there would be no donation. Article 6 allows this to happen.

Textbook knowledge suggests that emissions trading should not be heavily taxed. The reality is far from textbooks, so there is no doubt that transactions are going to be taxed. Yet global climate protection requires that Article 6 is not abused for ideological reasons. Unfortunately, as it was phrased, it can hamper international cooperation, and leave the poorest ones without prospects for financial assistance. At the Katowice UNFCCC meeting in 2018 (COP-24), Brazil insisted that CDM is continued (Stavins, 2018). Prospects for implementing Article 6 are dim.

Additional confusion is related to the role of forestry. A popular wisdom says ‘trees produce oxygen’; forests are considered gigantic lungs letting people survive in the planet. Indeed the forest makes a wonderful ecosystem and deserves to be protected carefully. Nevertheless, stories about ‘oxygen production’ are not quite correct.

The forest stores carbon, and burning a hectare leads to an emission of carbon dioxide. An average hectare of a Polish forest stores roughly 260 m³ of timber (GUS 2017). Following chemistry experts, one can estimate that every cubic meter of timber stores 1,000 kg of carbon dioxide. If the trees were burnt, then the carbon dioxide emission from an average hectare would have been 260 tons roughly. Forest fires happen, but they do not pose a catastrophic problem in Poland (they do in some other countries). The greater part of timber – after felling – is sent to manufacturing, especially to furniture and paper industries. Even though carbon dioxide stored in the trees is not released into the air immediately, it will end up there anyway. Timber products will become a waste sometime in the future, and they will emit carbon dioxide. The only difference with the forest fire is that emission will be postponed.

Even in the absence of human population, forests could not transform carbon dioxide into oxygen without any constraints. Trees do not live forever. Thanks to photosynthesis, they increase their mass for several (perhaps dozens of) decades. After sometime, this increase weakens and levels off completely. Decay processes start to dominate and the mass of trees decreases. Some tissues disintegrate and return to atmosphere in the form of carbon dioxide. The dead wood moulders and becomes the source of nutrients for other organisms. At the same time, it emits carbon dioxide into the atmosphere.

Only a young forest absorbs carbon dioxide and produces oxygen. A mature forest – ecologists call it a climax ecosystem – is neutral for the carbon balance. Deforestation negatively contributes to this balance, while planting trees where there was no forest contributes positively.

It should be emphasised that there are two climate-related issues that forests contribute to. One is carbon dioxide balance and the second is carbon sequestration. As old forests may emit more carbon dioxide than they fix in photosynthesis, their long-run contribution to carbon balance is neutral. Nevertheless, their contribution to carbon sequestration is valuable. There is less carbon dioxide in the atmosphere, if carbon is stored (sequestrated) in the forest. The role of forests is even more important, because some carbon is stored in the soil (Luyssaert et al., 2008). Therefore, it will not be released immediately once the forest is cut (or burnt).

From the point of view of environmental protection, a young forest is not so valuable as an old one. And conversely: what we appreciate in old tree stands, that is, hollows, rotten wood, landscape amenities and so on, is not useful from the point of view of carbon dioxide balance. Hence addressing the climate change by afforestation cannot be reconciled with environmental protection easily. In the long time perspective, what was captured by trees can be released into the atmosphere anyway. In the short run, when the forest is young and contributes to the atmospheric carbon dioxide balance in a positive way, it will not start to perform ecological functions that are essential for nature. It has to be cut down and substituted with newly planted trees before vital ecological processes start to develop.

Interest in climate change triggered speculations about a potential contribution of forestry. Protecting the global climate calls for a reduction in carbon dioxide emission. The emission comes from deforestation, among other things, but climate protection cannot succeed if the burning of fossil fuels continues.

The Paris Agreement, and especially its acceptance of INDCs – even those disappointing ones – is an important element of the global climate protection strategy. It is obvious that the Annex I countries interested in climate protection will not press very hard to free INDCs from declarations, which include forestry projects. However, with respect to Annex I countries – such as Poland – which adopted binding emission reduction commitments a long time ago, requirements are different. Such countries will be expected to abate emission not by documenting land use changes, but by promoting low carbon technologies in manufacturing and transport.

This was fairly obvious when preparing the meeting of parties to UNFCCC in Marrakesh in 2016 (so-called COP-22). INDCs declared by non-Annex I countries have been more than modest, and yet they were accepted. It is important not to discourage these countries from doing anything that transcends the Berlin Mandate, like calculating carbon dioxide absorbed by a newly planted tree (even though the tree can give it back to the atmosphere after some time). It is expected that by performing such calculations, non-Annex I countries will notice that planting trees does not reduce the emission of carbon dioxide, but merely transfers it to the future. They will notice that permanent reduction must include introducing low carbon technologies in manufacturing and transport.

Some people in Poland hope to acknowledge planting trees as an excuse for not reducing carbon dioxide emissions from manufacturing and transport. Indeed, Paris Agreement (2015) alludes to such a possibility, but its careful reading leaves no doubt that this is relevant for countries that have not taken any binding commitments (i.e., non-Annex I countries only). It would be useful to quote the relevant text of Article 5, where this possibility is mentioned.

In other words, the agreement encourages to use existing mechanisms – such as CDM – where Annex I countries can pay non-Annex I countries for climate-friendly activities. It also encourages to assist developing countries to build infrastructure adequate for multifunction forestry management. It does not include any provisions for Annex I countries to substitute their commitments to abate carbon dioxide with any domestic activities aimed at improving forest management.

One cannot exclude that UNFCCC will disappear in the future, the international community will sanction the lack of climate protection, and Annex I countries will substitute their abatement commitments with planting trees. For the time being, neither COP-22 nor subsequent conferences of its signatories have opened such possibilities. Signatories of the UNFCCC included in Annex I – such as Poland – cannot expect that afforestation will substitute for adopting low carbon technologies in manufacturing and transport.

In summing up these observations about climate change economics, it should be emphasized that the sum of protection costs is lower than the sum of damages resulting from the lack of appropriate action. The distribution of hypothetical damages is far from being uniform, with largest damages expected in tropical countries. Despite this, almost all these countries – not included in the Annex I – insist on keeping the Berlin Mandate that gives them an illusion of being privileged. Privileges are problematic, because Berlin Mandate frees them from binding commitments, yet at the cost of further growth of carbon dioxide emission, which is particularly harmful for these countries.

The fact that the sum of protection expenditures is lower than the sum of benefits does not result in taking adequate actions if the good concerned is a public one. Under such circumstances, actions taken by an individual country must be justified by benefits enjoyed by this country irrespective of what others will do. Climate-friendly measures required worldwide go much further than this condition. Yet international community is not ready to cooperate at the scale that is necessary in order to protect the climate effectively.

Recent meetings of parties to UNFCCC demonstrate that coalitions for not taking adequate activities can be quite exotic. For instance, at the COP-24 meeting in Katowice, a coalition was convened by the USA, Russia, Saudi Arabia and Kuwait in order to veto a resolution to accept conclusions of the Intergovernmental Panel on Climate Change (IPCC) report, which demonstrated that the 2°C global warming leads to much higher damages than the 1.5°C one. The coalition forced a resolution, which welcomes the fact that the IPCC report was published on time. One could laugh at this if the predicament were not a serious one.

At the COP-25 meeting in Madrid, another exotic coalition (including Australia and Brazil) insisted on introducing loopholes to the article 6.2 of the Paris Agreement in order to allow for some double counting. International community is still far from taking effective steps under the UNFCCC.