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Environmental Economics Seminar Series
Department of the Environment, Sport and Territories, 1996
ISBN 0 642 24879 6
Business Council of Australia
As described in Mick Common's background paper for this seminar, the climate change problem is a classic case of a Type III problem involving reciprocal externalities and spillovers - in the simple two country model activity A causes damage in A and B, and activity in B causes damage in A and B.
As Mick points out the essential issue in Type III situations is the incentive structure facing nations in regard to action to reduce environmental damage. In the simple two country model the optimal global outcome requires joint action (see Figure 1 reproduced from the Common paper). When both countries act together the level of emission reduction is greater than when either acts unilaterally. Both incur domestic abatement costs, but neither suffers from any loss of trade competitiveness. Both countries are better off than doing nothing but neither is as well off as it would be if it did not act and the other did. Each country has an incentive to free ride on the emissions abatement of the other, if it can.
Given that each has this incentive not to act on domestic emissions, in the absence of some kind of agreement between nation states, there will be no emission abatement anywhere. However, if each could be assured that the other would act if it did, there would be incentives to act as both would be better off than the status quo.
All parties are better off as participants in an effective international agreement that each acts to reduce emissions.
As simple as this model is it effectively points to a fundamental weakness in the Climate Change Convention ( Figure 2). That is the explicit delineation of commitments according to whether a country is classified as Annex 1 or not. (Annex 1 countries are OECD countries plus countries in transition.) Under the current terms of the Convention, Annex 1 countries have much more explicit and extensive commitments than do non-Annex 1 countries. Consequently we have two elements to this problem:
To look it in another way, if Annex l countries implement costly policies to abate emissions the following results:
Australia, for a number of reasons, has been well aware of this fundamental problem and argued strongly for developing countries to be more effectively bought into the process over time.
One key factor in Australia's sensitivity and understanding of this issue is the significance of export products' which embody emissions, especially energy intensive exports. A paper released this week by Rob Sturgess of the Treasury highlights the growing significance of energy intensive exports for Australia. Confirming this trend recent work by ABARE has projected that the growth in emissions embodied in exports will exceed the growth in emissions embodied in imports by 14Mt over the 1990s.
This trend makes Australia's exports increasingly vulnerable to the trade Competitiveness impacts of policies that impose additional emission abatement costs on some countries but not on others.
As Sturgess points out the classic example of the risk involved is the aluminium industry. For some time now aluminium producers have chosen to locate new production facilities in countries with low cost energy and have placed less emphasis on being close to final markets. In the case of Japan in the early 1980's production facilities were closed down and replaced offshore in countries such as Australia and Canada. Consequently while world aluminium consumption grew by 27 per cent between 1980 and 1992, world aluminium imports grew by 110 per cent over the same period (ABARE).
Capital for aluminium production remains mobile and future investment in the Australian industry could well be jeopardised if differential greenhouse policies affect our relative trade competitiveness.
Reinforcing our concern in this area is our location and the fact that non-Annex l countries are among our trading partners and competitors in this region.
The attitude of other developed countries to this issue also reflects their exposure to trade competition with non-Annex 1 countries. The US, Canada, NZ and Japan also supported greater involvement of developing countries.
On the other hand EU countries whose trade competition stems mainly from Annex l countries was less concerned about establishing a basis for non-Annex l commitments.
Developing countries led by the large emitters such as India and China are adamantly opposed to any further commitments for developing countries and stressed the fact that developed countries were yet to fulfil their commitments in terms of financial and technological transfers to developing countries. The potential for securing such transfers through the Climate Change Convention is well recognised by developing countries and any suggestion that they should accept more commitments or a process of 'transition' from non-Annex l classification to Annex 1 type responsibilities is strongly opposed.
At one recent negotiating session the Chinese ambassador declared that: 'China is a developing country, will continue to be and we will never give up that status!'
Not surprisingly given the weight of numbers the prospect of breaking down the inflexible barrier between developed and developing country involvement was always remote.
Now this difference is set to continue indefinitely. The Berlin Mandate that was agreed as the basis for negotiating further commitments beyond 2000 has the following provision (2b):
The process will...not introduce any new commitments for non-Annex 1 countries, but reaffirm existing commitments in Article 4.1 and continue to advance the implementation of these commitments in order to achieve sustainable development, taking into account Article 4.3, 4.5 and 4.7.
Articles 4.3, 4.5 and 4.7 of the current convention relate to provisions requiring developed countries to undertake financial and technological transfers to developing countries in order for them to implement the provisions of the Convention.
Article 4.7 states:
'The extent to which developing country Parties will effectively implement their commitments under the Convention will depend on the effective implementation by developed country Parties of their commitments under the Convention related to financial resources and transfer of technology and will take fully into account that economic and social development and poverty eradication are the first and overriding priorities of developing country Parties.'
While reference is made to establishing objectives for developed country commitments out as far as 2020 no reference is made to a time frame for reviewing developing country involvement.
Under this Mandate we are left some fundamental conflicts:
On the one hand the Convention and the Berlin Mandate, reflecting political realities and perhaps some moral obligation, requires developed countries to take the lead, to commit to emission limitation and to facilitate financial and technological transfers to developing countries.
However, these commitments are not likely to be cost effective in terms of global emission abatement and could have significant trade competitiveness and investment consequences for those countries. If so they are likely to lead to a significant leakage of emissions to non-Annex countries.
The more significant these trade competitiveness and investment effects are the less incentive there is for non-Annex 1 countries, no matter what their state of development, to accept the emission abatement commitments that will ultimately be necessary if the ultimate objective of the Convention is to be met.
Clearly the way ahead will not be easy under these circumstances but I suggest the following will represent the way things might unfold.
Three interwoven strands of policy development are likely:
Strand 1 - No regrets measures in Annex 1 countries
In the first instance it is appropriate that developed Countries continue to implement cost effective and voluntary measures to exploit the Potential for 'no regrets' opportunities to abate greenhouse gas emissions and enhance sinks. Conscientious pursuit of no regrets measures, especially if undertaken with the cooperation of industry, will deliver appreciable net emission abatement without jeopardising the competitiveness of industry.
Microeconomic reform and removal of industry subsidies will be important Strand 1 measures.
Strand 2 - Reducing net greenhouse gas emissions in developing countries
Within the constraints of the Convention cost effective opportunities for emission reduction and sink enhancement in developing countries where energy efficiency is low, energy demand is growing rapidly and land use measures could offer both greenhouse and other environmental benefits will need to be pursued. Further emphasis will have to be given to establishing viable institutional and financial mechanisms to achieve effective action in developing countries in a way that is acceptable to those countries. Joint implementation is a key mechanism but other aspects of the FCCC relating to technology transfer and financial arrangements will also be important.
Strand 3 - Research into new technologies
Given the imperative for economic development in developing countries and world population growth, it is inevitable that there will be huge growth in world energy demand and greenhouse gas emissions. Accordingly, a significant part of the long term solution to the greenhouse problem will come from new energy generation and energy enduse technologies implemented globally.
This will be complemented by technologies including carbon dioxide sequestration/disposal and reduction of non-carbon dioxide emissions. An effective public and private research program should start to deliver solutions for adoption early next century. The cost of conversion to new technology will be significantly reduced if existing capital equipment is allowed to operate for its productive life.
Implementation of new technologies will require adoption of new production systems and associated management practices. In addition to technological change, it seems likely that structural changes and possibly adaptation will need to take place within societies e.g. the nature of cities and means of work and communication.