The “Rulebook” for the Paris Agreement puts flesh on the bones of the skeletal 13-page Agreement, and was completed last year at COP24 in Katowice, Poland, with the exception of one very important part of the Agreement, namely Article 6, which potentially provides for international carbon markets and other forms of cross-border cooperation. Watch for key developments in Madrid!
Key Challenge for Long-Term Success of the Paris Agreement
There are two necessary conditions for ultimate success of the Paris Agreement. First, adequate scope of participation. This has been achieved, with meaningful participation from countries representing some 98 percent of global emissions—or some 85 percent if the U.S. withdraws in November, 2020 (compared with the 14 percent of global emissions from countries committed to emissions reductions under the current, second commitment period of the Kyoto Protocol). The other necessary condition is adequate ambition of the individual national contributions. This is where the greatest challenges lie.
The very element of the Paris Agreement that has fostered such broad scope of participation—namely, that the individual national “pledges” (Nationally Determined Contributions or NDCs) are anchored in national circumstances and domestic political realities—implies that individual contributions may not be sufficient, due to the global commons nature of the climate change problem, and the attendant free-rider issues.
So, are there ways to enable and facilitate increased ambition over time? Linkage of regional, national, and sub-national policies can be part of the answer—connections among policy systems that allow emission reduction efforts to be redistributed across systems. Linkage is typically framed as between cap-and-trade systems, but regional, national, and sub-national policies will be highly heterogeneous. More about this below.
Merits and Concerns Regarding Linkage
Linkage facilitates significant compliance cost savings by allowing firms to take advantage of lower cost abatement opportunities in other jurisdictions. According to one recent study, costs could—in theory—be reduced to 25 percent of what they otherwise would be! Also, linkage means improved functioning of markets by reducing market power and price volatility, and there are political benefits to linking parties as a sign of momentum when political jurisdictions band together. Another advantage is administrative economies of scale. Finally and very importantly, linkage allows for the UNFCCC’s key equity principle of “common but differentiated responsibilities and respective capabilities” (CBDR) to be achieved without sacrificing cost-effectiveness.
There are also some legitimate concerns about policy linkage. First, there are distributional impacts, both in the form of redistribution within jurisdictions, and redistribution across jurisdictions. Such impacts are politically problematic. There is also the automatic propagation of some design elements, in particular, the cost-containment elements of banking and price collars which propagate from one linked system to another. For that matter, weak design in one jurisdiction affects prices and quality in all linked jurisdictions. And price shocks can propagate through linked jurisdictions. Finally, there is decreased autonomy, as rules are set jointly by all linked parties.
Linkage and the Paris Agreement
There are three distinct but closely related levels of relevant policy action. First, national (or regional) governments can establish emission-reduction policies, including carbon taxes, cap-and-trade systems, and performance standards. Second, these jurisdictions can link their policy instruments through mutual recognition of permits, allowances, or credits via bilateral agreements. This allows trade of these units across international borders, which facilitates lower-cost achievement of the aggregate target. But such transfers of emission reduction responsibilities and actions need to be correctly counted toward compliance with respective NDCs under the Paris Agreement. This is where Article 6 comes in!
In particular, Article 6.2 provides for Internationally Transferred Mitigation Outcomes (ITMOs) and Corresponding Adjustments, which together can function as the international accounting mechanism to correctly reflect a multiplicity of international private-sector exchanges (under various international linkages).
In other words, I view ITMOs as units of accounting for Corresponding Adjustments, not as a medium of exchange for government-government purchase and sale. Otherwise, Article 6.2 would become equivalent to the Kyoto Protocol’s Article 17 (international emissions trading), and will fail as that did, because governments are not cost-minimizing agents, and lack requisite information even if they were (Hahn & Stavins, “What Has the Kyoto Protocol Wrought? The Real Architecture of International Tradeable Permit Markets,” 1999).
Is Heterogeneity a Challenge for Linkage?
Yes, it can be. There are three major categories of heterogeneity that can pose challenges to effective international policy linkage under the Paris Agreement. First, there are heterogeneous policy instruments: cap-and-trade; tradable performance standards; emission reduction credits (offsets); taxes; and performance standards. Second, there are heterogeneous jurisdictions and geographic scope: regional, national, and sub-national; and status under the Paris Agreement (Party and non-Party). Third, the NDC targets themselves area highly heterogeneous: hard (mass-based) emissions caps; relative mass-based emissions caps (relative to BAU); rate-based emissions caps (per unit of economic activity or per unit of output); and non-emissions caps, such as some degree of penetration of renewable energy sources. Also, there are differences in base year, target year, sectors, GHGs, estimated global warming potential, and conditionality.
Is Linkage Among Such Heterogeneous Policies Feasible or Wise?
With Michael Mehling (MIT) and Gilbert Metcalf (Tufts University), I have carried out research on heterogeneous linkage and the Paris Agreement (“Linking Climate Policies to Advance Global Mitigation.” Science 359, 2018). Among our major findings is the following. Most features of heterogeneity do not present insurmountable obstacles to linkage, but some present real challenges, and indicate the need for specific accounting guidance to avoid double-counting. Article 6.2 provides an obvious home for this accounting guidance (Schneider, Duan, Stavins, Kizzier, Broekhoff, Jotzo, Winkler, Lazarus, Howard, and Hood. “Double counting and the Paris Agreement rulebook.” Science 366, 2019).
The Outlook for Heterogeneous Linkage under Article 6.2 of the Paris Agreement
The negotiators in Madrid have an opportunity to define clear and consistent guidance for accounting for emissions transfers under Article 6.2. A robust accounting framework can foster successful linkages of climate policies across jurisdictions. But if guidance extends much beyond basic accounting rules—such as implicit taxes on cooperation via what have been termed “share of proceeds” and “net global emission reduction”—then restrictive requirements will impede effective linkage, and thereby drive up compliance costs. True to the spirit of the Paris Agreement, less may be more!
So, a combination of sensible common accounting rules and absence of restrictive criteria and conditions can accelerate linkage, allow for broader and deeper climate policy cooperation, and—most important—thereby increase the latitude of Parties to scale up the ambition of their NDCs.
Only time—and the work of the delegates in Madrid—will tell.
This post originally appeared on Robert Stavins’s blog, An Economic View of the Environment.
