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Politics and Economics of Second-Best Regulation of Greenhouse Gases: The Importance of Regulatory Credibility

  • Valentina Bosetti

    (FEEM and CMCC, Italy. Visiting Fellow at Princeton Environmental Institute)

  • David G. Victor

    (International Law & Regulation (ILAR) at UC San Diego, School of International Relations and Pacific Studies)

Modellers have examined a wide array of ideal-world scenarios for regulation of greenhouse gases. In this ideal world, all countries limit emissions from all economic sectors; regulations are implemented by intelligent, well-informed forward-looking agents; all abatement options, such as new energy technologies and forestry offsets, are available; trade in goods, services and emission credits is free and unfettered. Here we systematically explore more plausible second-best worlds. While analysts have given inordinate attention to which countries participate in regulation—what we call “variable geometry”—which has a strikingly small impact on total world cost of carbon regulations if international trade in emission credits allows economies to equilibrate. Limits on emission trading raise those costs, but by a much smaller amount than expected because even modest amounts of emission trading (less than 15% of abatement in a plausible scenario that varies the geometry of effort) have a large cost-reducing impact. Second best scenarios that see one sector regulated more aggressively and rapidly than others do not impose much extra burden when compared with optimal all-sector scenarios provided that regulations begin in the power sector. Indeed, some forms of trade regulation might decrease the financial flows associated to a carbon policy thus increasing political feasibility of the climate agreement. Much more important than variable geometry, trading and sectors is another factor that analysts have largely ignored: credibility. In the real world governments find it difficult to craft and implement credible international regulations and thus agents are unable to be so forward-looking as assumed in ideal-world modelling exercises. As credibility declines the cost of coordinated international regulation skyrockets—even in developing countries that are likely to delay their adoption of binding limits on emissions. Because international institutions such as treaties are usually weak, governments must rely on their own actions to boost regulatory credibility—for example, governments might “pre-commit” international regulations into domestic law before international negotiations are finally settled, thus boosting credibility. In our scenarios, China alone would be a net beneficiary of pre-commitment that advances its carbon limits two decades (from 2030, in our scenario, to today) if doing so would make international regulations more credible and thus encourage Chinese firms to invest with a clearer eye to the future. Overall, low credibility is up to 6 times more important in driving higher world costs for carbon regulations when compared with variable geometry, limits on emission trading and variable sectors. In this paper, we have not explored the other major dimension to the second-best: the lack of timely availability of the full range of abatement options, although our results suggest that even this will be less consequential than credibility.

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Paper provided by Fondazione Eni Enrico Mattei in its series Working Papers with number 2010.29.

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Date of creation: Mar 2010
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Handle: RePEc:fem:femwpa:2010.29
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  1. Valentina Bosetti & Carlo Carraro & Massimo Tavoni, 2009. "Climate Change Mitigation Strategies in Fast-Growing Countries: The Benefits of Early Action," Working Papers 2009_13, Department of Economics, University of Venice "Ca' Foscari".
  2. Bosetti, Valentina & Carraro, Carlo & Sgobbi, Alessandra & Tavoni, Massimo, 2008. "Modelling Economic Impacts of Alternative International Climate Policy Architectures: A Quantitative and Comparative Assessment of Architectures for Agreement," CEPR Discussion Papers 6995, C.E.P.R. Discussion Papers.
  3. Valentina Bosetti & Carlo Carraro & Massimo Tavoni, 2008. "Delayed Participation of Developing Countries to Climate Agreements: Should Action in the EU and US be Postponed?," CESifo Working Paper Series 2445, CESifo Group Munich.
  4. Aldy, Joseph Edgar & Pizer, William, 2011. "The Competitiveness Impacts of Climate Change Mitigation Policies," Scholarly Articles 5688779, Harvard Kennedy School of Government.
  5. repec:cup:cbooks:9780521865029 is not listed on IDEAS
  6. William Nordhaus, 2005. "Life After Kyoto: Alternative Approaches to Global Warming," NBER Working Papers 11889, National Bureau of Economic Research, Inc.
  7. Valentina Bosetti, Carlo Carraro, Marzio Galeotti, Emanuele Massetti, Massimo Tavoni, 2006. "A World induced Technical Change Hybrid Model," The Energy Journal, International Association for Energy Economics, vol. 0(Special I), pages 13-38.
  8. Valentina Bosetti & David Tomberlin, 2004. "Fondazione Eni Enrico Mattei," Working Papers 2004.102, Fondazione Eni Enrico Mattei.
  9. repec:cup:cbooks:9780521875684 is not listed on IDEAS
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