Efficiency-driven policies to encourage the Chinese to clean up their CO2 act

China last year overtook the US as the largest national emitter of CO2. This will crystallize preexisting concerns among developed countries that China’s emissions (as well as those of Indonesia and India) will need eventually to be controlled.

I have suggested two approaches to dealing with this issue:

(i) Introducing an international carbon tax with sufficient bite to meet Greenhouse gas reduction targets internationally and to levy tariffs on imports from non-complying countries – those that do not adequately impose the carbon tax. This is the somewhat coercive Stiglitz enforcement mechanism proposal. Non-taxing polluters are excluded from free trade because they are unfairly leaning on the rest-of-the-world by not internalizing their emissions. They are being levied with import tariffs to compensate for their environmental theft in exactly the same way that France seeks to attack US non-compliance with Kyoto.

The Stiglitz proposal moreover is designed to switch the tax base internationally from taxing socially-desirable pursuits (work-effort, saving) to pursuing double-dividend advantages from taxing social ‘bads’ such as pollution.

The attractive feature of this program is that it prevents 'carbon leakage'. By imposing direct restrictions on countries such as China it becomes impossible for pollution firms in developed countries to simply relocate to developing countries. Carbon leakage means jobs are lost in developed country and there is no improvement in the global environmental situation. This is the weakness of unilateral moves toward dealing with climate change - and indeed a weakness of the Kyoto Protocol.

Ultimately all countries need to tax carbon emissions or to be penalised by being excluded from trade.

(ii) Setting strict enough carbon emission quotas on complying developed countries (but not seeking to cap emissions from developing countries) to meet very stringent aggregate global emission targets but allowing developed countries to buy carbon credits from emission reductions that achieve via investments in developing countries. This is equivalent to the Clean Development Mechanism proposed (and used) under Kyoto. The difficulty with this proposal is that, as discussed in an earlier post, incentives can be distorted in developing countries. For example, incentives can be created to generate lots of pollution in order to make a sale.

I haven’t thought through the details of these respective viewpoints. My views might back-flip – I suspect there are intricacies here - and I might well have missed something entirely obvious. But I am increasingly coming to the view that option (ii) – despite its problems – has a much to recommend it. Aut least in the short-term before policy option (i) can be seriously considered.

Think of an analogy with conserving biodiversity existence values. These are the values associated with the happiness people experience from knowing that biodiversity species remain extant and can be thought of as a global public good. A species conserved in China contributes as much happiness as one conserved in Australia. Reflecting this suppose wealthy countries value the conservation of biodiversity irrespective of where it is located for existence value reasons and that these wealthy countries have a higher preference for conservation than do poorer developing countries. Suppose too that the options for conservation are better in developing than developed countries – there are lower cost conservation options in developing countries simply because very little conservation effort has been made. Then on efficiency grounds there is a case for resource transfers from rich to poor countries to effect good conservation outcomes on cost-efficiency grounds. These are not ‘charitable’ contributions but simply a consequence of seeking to best allocate conservation expenditures and where taxes to fund such conservation effort are set equal to marginal biodiversity conservation values in providing the global public good.

Roughly speaking developed countries have high willingness-to-pay reflecting their high marginal valuations on conservation. Moreover, the best opportunities to conserve are in developing countries where willingness-to-pay is lower. A resource transfer from rich to poor countries resolves this imbalance. (I once spelt out the analytics of this in a couple of published papers – unfortunately no online versions are available).

Does not an equivalent argument apply to CO2 emissions? Using the argument that the ‘environment is a luxury good’ (there are higher demands for environmental prissiness from rich countries) suggests that countries like the US and Australia have a higher demand for environmental prissiness than will (for example) the Chinese who are mainly targeting their quest for material wealth – they will kill* any animal that moves and have probably one of the environmentally dirtiest societies on earth. Being non-emotive, the Chinese have a low preference for conserving the natural environment – they want growth that will move them out of their miserable current circumstances.

Chinese energy consumption is low relative to developed countries but energy efficiencies are also low so that the opportunities for energy conservation in China are abundant and cheap as China moves toward higher energy consumption levels. Given the disparity in objectives between rich and poor countries and given that CO2 emissions are a global public bad it might make sense for there to be a transfer from wealthy to poor countries such as China to clean up the damage they are creating.

Proposal (ii) creates the incentives for the private sector to do this via a huge investment program that makes money by expanding the clean energy generation technologies in the west by cleaning up the dirt in the developing world. Yes there are huge incentive problems but the proposal to generate a developed country capital market response to cleaning up in the developing world will at least help to deal constructively with global warming issues.

This is a broad sketch since one needs to account for growing Chinese energy demands even if energy conservation is promoted. Moreover, while China has been singled out, many developing countries fit into the Chinese situation. In the longer-term it is essential to seek a transition whereby all countries take care of their own environmental damages. Indeed unless that happens measures to control emissions in deverloped countries will simply be swamped by environmental grubs in the developing world.

* The Chinese have no animal protection laws and their treatment of nature is appalling. See this YouTube if you have a strong stomach.