Does a Clean Development Mechanism Facilitate International Environmental Agreements?

Abstract

When politicians negotiate in international climate conventions they may suffer from incomplete information for each other’s preferences for reaching an agreement. As is known, this may cause failure to reach an efficient cooperative agreement. We study the role of cross border abatement provisions in the likelihood of such failure. For instance, the clean development mechanism was introduced in the context of the Kyoto Protocol to allow countries to make efficiency-enhancing use of cross-country low-cost mitigation opportunities. We use a simple bargaining framework to uncover why this mechanism may reduce the likelihood of reaching an efficient cooperative climate agreement.

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Notes

  1. 1.

    See Böhringer (2003) for a critical account of the limited achievements of the Kyoto Protocol, and Carbon Pulse (2016) for the ITMOs.

  2. 2.

    Reducing the problem to a North-South, two-player setup is a frequently used abstraction; see, e.g., Courtois (2010), Courtois and Tazdait (2014) and Hong (2014). According to observers, the policy controversy and the distributional conflict shifted slightly in later years. At the 2014 UN Climate Change Conference in Lima, for instance, questions about how to treat the economically strong and fast-growing emerging countries (see, e.g., Endres 2014) that formerly – but no longer – belonged to the group of less-developed low-emission countries moved to the forefront.

  3. 3.

    This assumption evidently removes many important and complex issues from the picture, such as the issue of alliance formation and coordination within the groups. These are discussed elsewhere and are tangential to our main focus of interest. Caparrós and Péreau (2013), for instance, study how such coalitions can be formed.

  4. 4.

    For an elaboration of this type of information asymmetry see Konrad and Thum (2014). Other types of incomplete information have been discussed; see, for instance, Caparrós et al. (2004).

  5. 5.

    This is in contrast to models of cooperative Nash bargaining or non-cooperative bargaining under complete information where negotiations can never fail. Models that employ Nash bargaining in the context of abatement consider the role of unilateral commitment on abatement (Hoel 1991), commitment on technology choices (Buchholz and Konrad 1994), or investment in R&D (Beccherle and Tirole 2011), prior to bargaining.

  6. 6.

    For a comprehensive survey on the CDM literature, see Paulsson (2009). The objectives of this Clean Development Mechanism (CDM) were twofold: On the one hand, developing countries should benefit from technology transfers and achieve a sustainable development. On the other hand, the industrialized countries should be able to minimize their abatement costs. It is this latter objective of the CDM which our paper focuses on. The industrialized countries will benefit if some abatement projects can be carried out at lower costs in high-polluting industries abroad. Due to the lower cost, industrialized countries may even find it optimal to increase their commitment toward abatement compared to a scenario without CDM.

  7. 7.

    Aresin (2013) focuses on the strategic interaction between countries. She analyzes the welfare effects of the CDM, depending on whether low-cost abatement opportunities in the non-Annex I countries are allocated to firms from these country.

  8. 8.

    As suggested by one of the reviewers, the coalition literature also employs the assumption that successful negotiations lead to emissions that are efficient for the group of cooperating countries. He/she also offers an interpretation of the situation of negotiation failure as one where only countries of the North form a coalition, and the situation of negotiation success as one where the grand coalition is formed.

  9. 9.

    There may be scientific uncertainty as to what the globally efficient level of abatement is. But as information about this is symmetric between N and S, the efficient outcome remains well-defined.

  10. 10.

    In practice, the bargaining about individual CDM deals occurs at the firm level. To facilitate the formal analysis we assume that the firms in the North capture the entire gains from trade in that bargaining process. The firms in the North simply reimburse the extra costs of the South due to abatement. However, firms in the North would be willing to pay more for the additional abatement up to the price of the permits in the market of the North.

  11. 11.

    Benefits of mitigation can be expected to be unevenly distributed within N or S, but we disregard such intra-country equity issues and assume that the benefits can be uniquely aggregated and represented by these functions.

  12. 12.

    Assumption (HR) holds for many commonly considered probability distributions and is a standard regularity assumption in contract theory.

  13. 13.

    If N could use these opportunities, then full crowding out with \(m_{{ SS}}=0\) emerges in the unique Nash equilibrium.

  14. 14.

    This assumption is not crucial for our model as any additional cost of mitigation in the South can be offset by adjustments in the transfers, which will be discussed later.

  15. 15.

    Bargaining is about the efficient \({\mathbf {m}}\) which is given. This is an important assumption that may be justified by the common knowledge assumption about the efficient \({\mathbf {m}}\). Any agreement other than this \({\mathbf {m}}\) leaves efficiency gains unexploited. A more sophisticated bargaining framework in the spirit of Martimort and Sand-Zantman (2013) and Helm and Wirl (2014) could allow N to offer a menu of possible contracts \(({\mathbf {m}},t)\). Player N could then typically implement the optimal principal-agent contract. In this case, the inefficiency from bargaining failure is replaced by an inefficient size or composition of \({\mathbf {m}}\) for all contracts with agent types, except ‘at the top’. In such a principal-agent framework, an analogous question to ours would be whether cross-border abatement in the default state increases or decreases the expected inefficiency that emerges in the principal-agent contract.

  16. 16.

    The complete formal analysis of corner solutions can be found in an earlier (working paper) version of this paper.

  17. 17.

    Including the political benefits would not alter the overall conclusion. It just makes securing a global environmental agreement even more beneficial if the expected political benefit is positive.

  18. 18.

    The outcome is also ambiguous when there is an interior solution without cross-border abatement [\(0<F(\sigma ^{1})<1\)] and a non-cooperative corner solution with cross-border abatement [\(F(\sigma ^{2})=1\)].

  19. 19.

    Problems that may occur with cross-border abatement in practical applications, such as the problem of whether a CDM provides additionality, are absent in our framework. By definition, all abatement units are additional here.

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Correspondence to Marcel Thum.

Appendix: S is the Proposer

Appendix: S is the Proposer

The Appendix discusses the case in which S makes an ultimatum offer to N. This offer consists of a transfer t from S to N as a compensation for N to implement the efficient amount of abatement. For space considerations we concentrate on the case of interior solutions.

If the offer is rejected then players N and S choose the amounts of mitigation that maximize their own rents and no transfers are paid. These amounts of mitigation are \(\left( m_{{ NN}}^{1},m_{{ SS}}^{*}\right) \) or \(\left( m_{{ NN}}^{2},m_{{ NS}}^{2},m_{{ SS}}^{*}\right) \), depending on the regime. If the offer is accepted then \(\left( m_{{ NN}}^{3},m_{{ NS}}^{3},m_{{ SS}}^{*}\right) \) is implemented and country S pays t to country N. The net benefits for proposer S change from \(\theta _{S}^{i}\) to \(\theta _{S}^{3}+\sigma -t\) and N’s payoff changes from \(\theta _{N}^{i}\) to \(\theta _{N}^{3}+t+\nu \). Player N accepts the offer if \(\theta _{N}^{3}+t+\nu -\theta _{N}^{i}\ge 0\), or

$$\begin{aligned} \nu \ge \theta _{N}^{i}-\left( \theta _{N}^{3}+t\right) \end{aligned}$$
(13)

for \(i\in \{1,2\}\). This inequality describes a one-to-one relationship between t and the critical \(\nu \) such that N accepts the transfer demanded if the transfer is at least equal to the t that solves (13) with equality. We denote this critical \(\nu ^{i}\) as a function of t as

$$\begin{aligned} \nu ^{i}(t)=\theta _{N}^{i}-\theta _{N}^{3}-t\quad \text {for}\quad i\in \{1,2\}. \end{aligned}$$
(14)

This function is linear in t and has a slope of \(-1\).

The bargaining-success probability as a function of t is \(1-G\left( \theta _{N} ^{i}-\theta _{N}^{3}-t\right) \). Proposer S chooses t to maximize

$$\begin{aligned} E\pi _{S,i}=\left( \theta _{S}^{3}+\sigma -t-\theta _{S}^{i}\right) \cdot \left[ 1-G\left( \theta _{N}^{i}-\theta _{N}^{3}-t\right) \right] . \end{aligned}$$

This expected payoff is the product of S’s actual gain in case of successful bargaining, times the probability of acceptance of the proposal. Differentiating with respect to t yields a first-order condition which can be rewritten as

$$\begin{aligned} \frac{1-G\left( \theta _{N}^{i}-\theta _{N}^{3}-t\right) }{G^{\prime }\left( \theta _{N}^{i} -\theta _{N}^{3}-t\right) }=\theta _{S}^{3}+\sigma -t-\theta _{S}^{i}. \end{aligned}$$
(15)

If this condition has an interior solution, we denote it by \({\hat{t}} ^{i}(\sigma )\) to distinguish it from the function \(t^{i}(\nu )\) in the previous section. Note that the left-hand side is weakly increasing in the transfer offered (due to Assumption (HR) of a non-increasing hazard rate), and the right-hand side is strictly monotonically decreasing in the transfer. Accordingly, there is at most one transfer level \({\hat{t}}^{i}(\sigma )\) that fulfills this first-order condition for each regime i and a given \(\sigma \). We further note that

$$\begin{aligned} {\hat{t}}^{1}(\sigma )>{\hat{t}}^{2}(\sigma ) \end{aligned}$$
(16)

Recall the one-to-one correspondence between t and a value of \(\nu \) such that responder N accepts transfer offer t if \(\nu >\nu ^{i}(t)\) and rejects the transfer offer if N’s true value of \(\nu \) is smaller than \(\nu ^{i}(t)\) in the interior range of \(({\underline{\nu }},{\bar{\nu }})\). With a mild abuse of notation, let \(\nu ^{i}(t)\) denote the political benefit necessary to make country N indifferent between accepting and rejecting offer t in regime i. As shown by (14), the respective functions \(\nu ^{i}(t)\) are linear and have a slope of −1. Further, \(\nu ^{2}(t)-\nu ^{1}(t)=\theta _{N} ^{2}-\theta _{N}^{1}>0\). Together with (16) and (14) this implies

$$\begin{aligned} \nu ^{1}({\hat{t}}^{1}(\sigma ))<\nu ^{2}({\hat{t}}^{2}(\sigma ))\text {. } \end{aligned}$$

The probability of bargaining failure is higher if cross-border abatement opportunities are available in the non-cooperative fallback.

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Konrad, K.A., Thum, M. Does a Clean Development Mechanism Facilitate International Environmental Agreements?. Environ Resource Econ 69, 837–851 (2018). https://doi.org/10.1007/s10640-016-0107-2

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Keywords

  • Clean development mechanism
  • International climate agreements
  • Bargaining
  • Incomplete information

JEL Classification

  • Q54
  • Q58
  • F53
  • H41