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close this bookThe Global Greenhouse Regime. Who Pays? (UNU, 1993, 382 p.)
close this folderPart II Resource transfers
close this folder6 North-South transfer
View the document(introduction...)
View the documentObligation to pay indices
View the documentRedistribution of incremental cost
View the documentBenchmarks
View the documentUN scale of payments
View the documentFinancing mechanisms
View the documentConclusion
View the documentNotes and references

(introduction...)

Obligation to pay indices
Redistribution of incremental cost
Benchmarks
UN scale of payments
Financing mechanisms
Conclusion
Notes and references

Peter Hayes

In the previous chapter, I calculated the incremental costs to different nations and groupings of nations arising from the carbon abatement scenario and protection against sea level rise. In this chapter, I redistribute these incremental costs based on historic contribution to climate change and ability to pay. As might be expected, the North is obliged to pay substantially more than it would if it ignores its historic contribution and its greater ability to pay than the South. And unless the South's cost is reduced to its obligation-to-pay, it could pay much more than it should - from 58 to 90 per cent more according to the following analysis.

Redistribution in accordance with this indice is then compared with the pragmatic distribution rule known as the UN scale of payments, and some benchmarks. As the obligation-to-pay index does not diverge much from the UN scale of payments, the latter could be very useful in judging national claims for exemption from the former in the climate change context.

Next, I examine how the substantial funds involved might be collected, generated, and transferred by a carbon tax, traceable permits, or sale of abatement services. This analysis shows that the carbon tax and traceable permits are feasible instruments to achieve the requisite financing in the South, but that the sale of abatement services would likely only supplement the former two mechanisms. Finally, I direct the reader to a summary of the major uncertainties that affect each of these links in the logical chain presented in this analysis.

Obligation to pay indices

'Obligation to pay' (OTP) is a composite indice based on two constituent measures 'ability to pay' (ATP) end 'historic contribution to climate change' (HCCC). The indice enables the issue of who should pay (who created the problem and who can afford to pay for the cleanup) to be separated from where abatement should be conducted (the cheapest sites). Here, this concept is used to determine the distribution of the costs of abatement and coastal protection that were calculated in the previous chapter, at high, medium and low abatement cost curves. First, I will briefly review the conceptual components of 'obligation-to-pay' as advanced in Chapter 4.

Ability to pay (ATP) is best formulated as follows:

ATP = GNP - [Population X (GNP/Capita) T'HOLD PQOL]

where:
ATP = ability to pay;
GNP = Gross National Product;
[Population x (GNP/capita) THOLD PQOL] = a basic need adjustment using a threshold physical quality of life or PQOL estimate set at
GNP = 1986US$1,800/capita.

This criterion is useful because it clearly shows who has gained economically from past pollution of the atmosphere. It also identifies who can afford to shoulder the burden of greenhouse gas abatement in the future. This ATP index does not include any special weighting for populations who are especially at risk from climate change, such as those of developing coastal and island states.

The second index that is used to determine overall obligation to pay is historic climate change contribution (HCCC) defined for a given nation as:

HCCC = national cumulative GHG - [Population x NDTHOLD]

where:

GHG = greenhouse gas emissions integrated contribution to atmospheric warming using a 100-year time horizon from year of emission. Here, carbon dioxide from fossil fuel usage is taken as a proxy for greenhouse gas emissions;

ND = natural debt, the national borrowing of the atmosphere's absorptive capacity in cumulative 1950-86 GHG emissions/1986 population;

NDTHOLD = a threshold 'natural debt' defined as the cumulative per capita emission that is attributable to the universal human right to an equal portion of atmospheric absorptive services such as the carbon sink. Any emission above this per capita level is treated as an excess borrowing that counts in the HCCC.

The HCCC of a given nation is weighted relative to its 1986 adult population on the grounds that current populations should carry the burden of ancestral cumulative damage and that national responsibility for climate change is proportional to national natural debt.

As was argued in Chapter 4, the HCCC is an important ethical and political concern that should be reflected in determining obligation to pay. Some critics contend that this criterion places too much emphasis on moral responsibility and not enough on current emissions. However, allowing past decision-makers to avoid liability for their historical contributions to cumulative and irreversible environmental degradation such as climate change fails to provide current decision-makers with an incentive to protect the rights of future generations. The current generation of leaders cannot disavow its obligation to pay off its natural debt from the immediate past at the same time as it claims to be adopting the principle of intergenerational equity. Moreover, the political leaders of the South are not about to let the North occupy all the global atmospheric commons without first obtaining significant compensation - a point stressed repeatedly by the Group of 77 in the negotiations over the Convention. A transparent, quantitative index of historical responsibility will facilitate greatly the ongoing negotiations over protocols on this issue. It is therefore the necessary starting point of meaningful bargaining over this issue, even if political-economic power ultimately elbows aside much of the moral imperative represented by the HCCC index.

These indexes can be combined into a total obligation-to-pay indice by either multiplication or addition. Each index could be weighted, for example, from concern with equity. Here, however, the indexes are simply added without weighting. Of course, politics would determine how the indexes would be combined in an actual negotiation. As both indexes give similar distributions of responsibility, the selection of one rather than both, or the best combination of the two, would be a pragmatic political question.

In Table 6.1 and Figure 6.1, I show the per centage distribution of national and aggregate obligation to pay. The South's obligation to pay is about 7 per cent, the North's about 73 per cent, and the East's about 20 per cent. With this indice, the incremental costs calculated in Chapter 5 can be redistributed between nations in accordance with their global obligation to pay, a procedure followed in the next sections.

If the obligation to pay indice were adopted in a protocol to the Climate Change Convention, then it should be recalculated periodically (say every five years) to reward those who have decreased their historic greenhouse gas contribution relative to projections; and to penalize those who have increased their historic greenhouse gas contribution relative to projections. A similar adjustment to obligation-to-pay should be made for each nation's achieved GNP per capita growth rates relative to those projected in the initial calculation of a nation's obligation to pay.

Table 6.1 Obligation to pay, combined index

Country   % of total % of group subtotal
North      
United States US 37 50
Germany (United) UG 8 11
Canada CA 3 4
Belgium BE 1 1
United Kingdom UK 6 8
France FR 4 6
Japan JAP 8 10
Italy IT 3 4
Australia AU 1 2
Greece GR 0 0
Netherlands NE 1 2
Spain SP 1 2
Portugal PO 0 0
Turkey TK 0 0
Subtotal, North NO 73 100
'East'      
Soviet Union SU 16 77
Rest of East Europe EE 5 23
Subtotal, East EA 20 100
'South'      
China CH 1 22
India IND 0 0
Indonesia INDO 0 0
Rest of South RoS 5 78
Subtotal South SO 7 100
TOTAL WORLD 100  

National obligation to pay = (% world ability to pay, at threshold income of (1986) US$1,800/ capita) + (historic contribution of cumulative emissions, 1950-86) - (1986 population (national) x natural debt threshold of 10 tonnes of carbon per capita (1986))

At first sight, these adjustments appear to increase the relative obligation-to-pay of the developing countries (which will rapidly increase their share of historic contribution to atmospheric carbon loading, and their ability to pay) and reduce the obligation of the developed countries (which will have an ever smaller share of the accumulated carbon contribution to the atmosphere and likely a lesser GNP growth rate than in the South). In reality, both adjustments would be sensitive to the effect of population growth on the 'basic needs' allowance in the obligation-to-pay indice. Therefore, the 'redistributive' impact of regular recalculation of the obligation-to-pay indice is indeterminate. High population growth in the South, for example, would increase its permitted 'basic needs' emissions that would not count toward its obligation to pay. It could (depending on the impact of population growth on GNP growth) also keep per capita income in the South below the basic needs threshold per capita income (US$1,8001capita) that determines ability to pay in this study.


Figure 6.1 Obligation to pay ability to pay + historic resp - natural debt threshold

If the emissions index in the obligation-to-pay indice is reanalysed using this study's projected population in and cumulative emissions up to 2025 for the North, East and South, then the North's total obligation to pay (updated for cumulative contributions from 1950 all the way to 2025) would increase by about 7 per cent, the East's by about 8 per cent, and the South's by about -14 per cent relative to the distribution of the obligation-to-pay indice in 198617 (58, 23, and 18 per cent respectively).

Conversely, if the basic needs allowance in the emissions component of the obligation-to-pay indice is pegged to its 1986 level (that is, a 1986 population level is used rather than the 2025 figure), then the shift in relative responsibility due to the increases in cumulative contribution from 1987 to 2025 is from the North (-5 per cent) to the East (+1 per cent) and the South (+4 per cent).

How population growth is treated in the two indexes that constitute the obligation-to-pay indice is therefore critical to the impact of its periodic adjustment. The choice of which population to use is political, and there being no 'right' answer. In any case, whatever its direction, the overall redistribution of obligation-to-pay arising from periodic adjustment is relatively small, even after thirty years of additional emissions. I therefore proceed using the current estimate of the obligation-to-pay index stated above in redistributing incremental costs.


Figure 6.2 Cost with and without OTP redistribution, Cases 7 and 3

Redistribution of incremental cost

In this section, I take the estimates of incremental cost developed in chapter 5 and redistribute between regions those costs that are 'excess' to their obligation-to-pay. As there are three incremental cost cases, so there are three calculations of redistribution of cost that follow.

Redistribution of high incremental cost

At the high abatement cost curve, the present value of the total cost is estimated at $5.6 trillion. The South's incremental cost, therefore, should be reduced to only 7 per cent of this global cost or $390 billion, or by 58 per cent of its unadjusted incremental cost. The difference - $529 billion - is treated as the responsibility of the North and is transferred to the latter's account which increases from 2.9 to 3.5 trillion dollars as a result.

This transfer - an annuity of $34 billion over the 30 year scenario period boosts the North's payment from 58 to 63 per cent of the global total (still short of its strict obligation-to-pay of 73 per cent). The residual difference between this distribution of global cost and that implied by the obligation-to pay indice now lies between the North and the East (and is not addressed further here). The latter incurs an incremental cost of $1.7 trillion, that is, about 9 per cent more than its obligation-to-pay. Thus, another transfer, this time from the North to the East, may be justified.

Expressed as an annuity of thirty annual payments that are equivalent to the total present values and adjusted for the North-South transfer, the bill at high abatement cost is $229 billion per year in the North, $108 billion in the East, and $25 billion in the South, for a global annual cost of $362 billion (rounded to $363 billion in box on page 151). The annual cost in billions of dollars redistributed by the obligation-to-pay indice is displayed in the box above and Figure 6.2.

Redistribution of medium incremental cost

In Case 3, the application of the obligation-to-pay indice results in the North's cost increasing from $104 billion (or 16 per cent of the total) to $605 billion (or 82 per cent of the total) due to the transfer of $442 billion from the South to its account.

In Figure 6.2, I show the resulting overall distribution of annual cost in billions of dollars. The North pays an annual bill of $39 billion (of which $29 billion is a transfer to cover the costs of the South not covered by the South's own obligation to pay). The East is responsible for about $5 billion per year while the South is responsible for about $3 billion per year of the global annual total of $48 billion.

Distributed cost, Cases 1 and 3

I. Redistribution of cost, high cost curve, case1

Definition: Incremental Cost 1, using Nordhaus marginal cost curve and net present value of incremental cost to each area adjusted to account for South's excess of cost above its obligation-to-pay between 1995-2025, in $billion/year

Global Cost, total nett present value (NPV)a = 5577 billion
South's obligation-to-pay = 7% of global cost = 390 billion (NPV)

South's obligation-to-pay as % of South's total abatement and coastal protection cost= 42%

North-to-South transfer to cover the difference between South's obligation-to pay and its total cost = 529 billion (NPV)

North-to-South transfer expressed as an annuity = 34 billion/year
NPV of cost, adjusted for transfer according to obligation-to-pay

North East South Global  
3520 1667 390 5577 billion $ (NPV)
Annuity (adjusted for South's obligation-to-pay)
229 108 25 363 billion $/year
% of global annuity (adjusted for South's obligation-to-pay)
63 30 7 100  

II. Redistribution of cost, medium cost curve in south, case 3

Definition: Incremental Cost 3, using this study's estimated abatement cost curve in South, and US National Academy of Science cost curve for North and East, in net present value of incremental cost to each area adjusted to account for South's excess of cost above its obligation-to-pay between 1995-2025, in $billion/year

Global Cost, total nett present value (NPV)a = 739 billion
South's obligation-to-pay = 7% of global cost = 52 billion (NPV)

South's obligation-to-pay as % of South's total abatement and coastal protection cost=10%

North-to-South Transfer to cover the difference between South's obligation-to pay and its total cost=442 billion (NPV)

North-to-South Transfer expressed as on annuity = 29 billion/year
NPV of cost, adjusted for transfer according to obligation-to-pay

North East South Global  
605 83 52 739  
Annuity (adjusted for South's obligation-to-pay)
39 5 3 48 billion $/year
% of global annuity (adjusted for South's obligation-to-pay)
82 11 7 100  

III. % obligation-to-pay based on historic emissions and ability to pay

North East South Global
73 21 7 100 (% of total)

a From box on page 132
Source: Box on page 132 and text

Redistribution of low incremental cost

As I stated in Chapter 5, Case 2 provides no economic grounds for a transfer to the South. Expressed as an annuity, therefore, the North pays $10.6 billion per year in this scenario; the East $5.4 billion per year; and the South gains from a negative annual cost of $62 billion per year (see box, page 133 and Figure 5.13). On this basis, the North would not transfer additional resources to the South for the simple reason that the South should abate to the extent projected out of economic self-interest, without regard for the climate per se.

This result implies that developing countries can reap the advantage of being latecomers to industrialization. Rather than waiting for long-lived capital stocks to turn over, they may be able to install modern, resource saving technologies as they industrialize.

Conversely, the notion of enormous savings being reaped in many developing countries is incredible when juxtaposed against their evident inability to reduce the enormous waste in their existing economies, let alone massively abate their future emissions. Even if these low and negative cost technological opportunities exist, most developing countries are unable to finance the front end investments needed to tap the potential. Admittedly, the obligation-to-pay index does not provide an economic rationale for a transfer from the rich to the poor under these assumptions. Equally, only the rich states can provide the substantial concessional financing needed in the developing countries.

Developing countries face not only an absolute scarcity of investment resources with which to respond to climate change. They will also incur costs from intersectoral adjustment, trade impacts, human resource development, institutional change, and highly priced information, all of which will inhibit their ability to increase their energy efficiency. Overcoming these barriers to abatement will impose costs that are not reflected in the low abatement cost curve used in this case.

How much financing might be needed to meet these challenges so that the developing countries reduce their emissions as described in Chapter 5? The simple answer is that no one knows. One study states that developing countries need to redirect at least 2 per cent of their gross domestic products or about $58 billion in 1989 - toward human development priorities such as education, health care, and social services that are integral to sustainable development. At the June 1992 Earth Summit, UN officials estimated the cost of implementing a global sustainable development strategy as about $600 billion per year, of which about $125 billion must be financed externally in the form of technical and economic assistance. Only a portion of these costs would be attributable to carbon abatement activities; but not much abatement may be achieved unless such broad based development occurs.

The reader can imagine the size of this daunting task by supposing that within about three decades, all developing countries must have the same proportion of scientists and technicians in their population as do the rich countries today - arguably a prerequisite of realizing substantial carbon abatement. To do so, the developing countries would have to increase their number of scientists and technicians at 10 per cent per year, from today's 36.7 million to about 579 million in 2025. This growth in human resources would demand tens, perhaps hundreds of billions of dollars of investment in education and training each year.

In Chapter 14, I return to these issues that take us well beyond a technological approach to determining requisite transfers from the rich to the poor states. These difficulties also reveal the limits of a method that fuses a moral argument with a technological and economic approach to determining who should pay for a greenhouse gas regime. The obligation-to-pay method supplies some minimum estimates of the possible transfers but it may not be applicable in all cases and almost certainly must be supplemented with other approaches on pragmatic and political grounds.

Benchmarks

According to this approach, substantial transfers to the South may be required to fund the technological and economic costs not covered by its own obligation to pay. These fall within the range $29-34 billion per year for thirty years, depending on the underlying marginal cost assumptions. Thirty billion dollars per year is a reasonable mid-point estimate of the justified, minimal and additional financing needed by the South to achieve its required reduction targets. To this amount should be added a substantial sum to 'kickstart' the sustainable development process by training the scientists and technicians who will be needed to implement an abatement strategy in the South.

Thirty billion dollars or more per year is a lot of money. For example, current official development assistance (ODA) for all energy investment in the South currently amounts to about $10 billion per year. Total ODA ran at about $30 billion per year during the 1980s (reaching $46.9 billion in 1989 for the OECD). Total foreign direct investment to all developing countries was about $13 billion per year in the same period. Enabling the South to participate in a global climate change agreement would result in transfers on a scale that would create a new foundation for the political-economic interdependence of the North and the South, on a scale with current aid and foreign investment.

Conversely, world and national GDP growing at 3 per cent per year will increase by 240 per cent over the same period, rendering the annual transfer cost a declining portion of donor country GDP. The transfer to the South of about $30 billion per year pales into insignificance compared with agricultural production subsidies ($50 billion per year in the EC); military spending in the North or the South; or Third World debt (which resulted in a South-to-North net financial flow of $42.9 billion in 1989). There is little doubt that the North can afford to pay $30 billion per year even if it would be difficult to muster the political will needed to do so.

UN scale of payments

Negotiations on the allocation of payment are likely to begin with precedent. A commonly used focal point for bargaining is the UN scale of payments. Slightly modified, this scale formed the basis of contributions to the costs of the ozone agreement. A number of other UN trust funds for environmental purposes have also used weighted contributions based on the global assessment scale of the UN General Assembly. In this system, countries are rated according to a number of economic, geographic and demographic factors. The only limit is a 25 per cent ceiling for the US contribution since 1972. The use of differential scales that modify even the UN sliding scale allows countries to participate in an environmental agreement without incurring an insupportable cost. Under the Montreal Protocol, for example, Singapore contributes $1,500 annually but has the same membership rights as the United States which pays $300,000 per year.

Under the UN scale, the North pays about 77 per cent, the East about 14 per cent, and the South about 9 per cent of total UN cost (see Table 6.2 and Figure 6.3). It is interesting to compare this with the obligation-to-pay index referred to earlier. The North's obligation-to-pay is about 73 per cent of global cost; the East's about 20 per cent; and the South's about 7 per cent. Negotiations on protocols to the Climate Change Convention are likely to proceed pragmatically by countries making bids to vary their contribution relative to the UN scale until consensus is reached. The obligation-to-pay index therefore provides a convenient method to analyse the validity of claims for special treatment with respect to the UN scale.


Figure 6.3 UN scale of payments, %

Financing mechanisms

Three instruments to finance the South's incremental costs beyond its obligation-to-pay have been canvassed widely. These are carbon taxes, traceable permits, and trade in abatement services. Below, I examine the role that each might play in transferring financial resources on a large scale.

The reader should note that I treat all three mechanisms as a means to an end: each of them is a way to ensure that reduction targets are achieved at least cost, from a global perspective. Minimizing the global cost of reduction (that is, efficiency) per se is not the overriding priority in this study, however. Rather, I aim to see how carbon emission reductions might be achieved efficiently in an equitable carbon reduction strategy. Equity has been defined here with respect to an overarching goal, the creation of a strategy to achieve the necessary emission reductions in accordance with obligation-to-pay as defined above. Taxes, permits and trade, therefore, are enlisted to minimize the costs of promoting an equitable and ecologically sustainable emissions strategy. As is proper, means have been subordinated to ends - however strange this relationship appears to some in the economic profession.

The reader should be alert that the numbers that follow are indicative and are used to explore the contours of the terrain rather than to provide precise answers. The results should not be interpreted as the 'real' figures. In short, I aim only to sketch the landscape rather than to produce a map with pinpoint accuracy.

Carbon tax

Many analysts have explored the possibilities of using a carbon tax to reduce demand to accord with emission quotas or an emission target. Here, I do not examine the pros and cons of different levels and types of carbon taxes. Rather, I determine the level of carbon tax in the North that would raise the necessary revenue needed for the transfer to cover the costs of the South that are the North's obligation-to-pay.

Carbon tax transfer

A. Assuming high abatement cost curve and redistributed cost, case 1 (billions $)

Annuity of North-South transfer according to obligation-to-pay index = 34 billion/ year
Net present value of carbon tax on projected northern emissions to finance the transfer annuity, after north has achieved own required reductions = 518 billion
Annuity of carbon tax revenue to fund transfer = 34 billion
Carbon tax level to achieve transfer annuity = 13$/T-C emitted

B. Assuming medium abatement cost curve and redistributed cost, case 3 (billions $)

Annuity of North-South transfer according to obligation-to-pay index = 29 billion/ year
Net present value of carbon tax an projected northern emissions to finance the transfer annuity, after north has achieved own required reductions = 445 billion
Annuity of carbon tax revenue to fund transfer = 29 billion
Carbon tax level to achieve transfer annuity = 11 $/T C emitted

Table 6.2 UN scale of payments

Group/Country   % of total UN payments % of total of group/country
North      
United States US 25.00 32.16
Germany United UG 9.36 12.04
Canada CA 3.09 3.98
Belgium BE 1.17 1.51
United Kingdom UK 4.86 6.25
France FR 6.25 8.04
Japan JAP 11.38 14.64
Italy IT 3.99 5.13
Australia AU 1.57 2.02
Greece GR 0.40 0.51
Netherlands NE 1.65 2.12
Spain SP 1.95 2.51
Portugal PO 0.18 0.23
Turkey TK 0.32 0.41
Rest of OECD/North RE 6.56 8.44
Subtotal, North NO 77.73 100.0
'East'      
Soviet Union SU 11.57 83.78
Rest of East Europe EE 2.24 16.22
Subtotal East EA 13.81 100.00
'South'      
China CH 0.79 8.60
India IND 0.37 4.03
Indonesia INDO 0.15 1.63
Rest of South RoS 7.88 85.75
Subtotal South SO 9.19 100.00
TOTAL WORLD 100.73  

Column one does not sum to 100 per cent due to rounding error and errors in source data
Source United Nations, Administrative and Budgetary Coordination of International Atomic Energy Agency, A/45/798, November 27, 1990, pp 23-27

In the box opposite, I show the carbon tax needed in our scenario to raise the revenue in the North to finance the transfer to the South. To calculate the tax, the North's total 'post-reduction' emissions (projected emissions minus required reductions, in the efficiency scenario in Chapter 5) are multiplied by the tax rate per tonne of emitted carbon in each year. The carbon tax that amasses an annuity based on the present value of this stream of future tax revenues, that equals the transfer implied by the obligation-to pay indice, is the tax adopted.

Two tax levels are derived, one for the high marginal abatement cost, Case 1, and one for the medium abatement cost, Case 3. (Each case generates a different estimate of the target transfer annuity, namely, $34 and $29 billion respectively). Carbon taxes of between $13 and $11 per tonne of carbon emitted achieve these target annuities. These tax levels are quite small compared with the carbon taxes that are computed by economists as necessary to dampen carbon emissions to a significant degree (according to which taxes of $20-120/T-C abated are required for reduction ratios of from 20 to 80 per cent).

Tradeable permits

Many analysts have argued for traceable permits instead of or to supplement carbon taxes. Based on limited US experience, traceable permits are argued to create flexible market incentives to reduce emissions at low administrative cost and lesser social cost. The system requires that total emissions be limited or that a cap be placed on the total number of permits issued. A mix of buyers and sellers must also exist with access to markets for permits. Trade must not be allowed above the total limit or without permits if permits are to maintain their value.

In principle, traceable permits favour technological innovation due to the continuing incentive for users to avoid having to pay for additional permits. Tradeable permits would permit states to enter voluntarily into an arrangement whereby one reduces its emissions in return for value provided by another which continues to emit, provided the sum of the two national limits combined is not exceeded. Whereas the major deficiency of a carbon tax is that policymakers will not know the tax level needed to achieve a given reduction level, a major inadequacy of a traceable permit system is that the price of the permits - and thus the cost of achieving limits on emissions cannot be determined in advance. The initial allocation of traceable permits as well as the administrative and enforcement mechanisms needed to implement a global regime based on permits (in the absence of world government) are two other major difficulties with the scheme.

I do not address the political feasibility of allocating permits in this study, although I did suggest a combined set of criteria in Chapter 5 with which to set a limit on national emissions. Thus, the cap on emissions was determined by setting emissions at a target level that was defined as 'sustainable' in terms of atmospheric carbon concentration and rates of temperature and sea level rise. I assume here, therefore, that the South is simply issued with an additional amount of saleable emission permits over and above those needed to meet its target required reduction trajectory (that is, it received en 'excess entitlement' that it can sell without being required to offset each sale with equal and additional abatement in the South); and that the same volume of emissions are deducted from the North's permits, forcing the North either to abate emission further, to meet its reduction targets, or to buy permits from the South.

I suppose further that the North would only buy permits from the South when a major price differential makes it attractive relative to its own marginal abatement cost in a given year of the abatement scenario. The upper limit on the permit price is set therefore by the North's marginal abatement cost. In principle, the South could sell excess permits at any price below that upper limit as it obtains marginal rent for any price above zero. (Of course, the lower the price, the more sales are needed to generate the requisite financing of the South's 'excess' incremental costs relative to its obligation to pay.) However, I assume that the South sells its permits only when the price offered is above its own marginal abatement cost, thereby setting a lower limit for the permit price.

This assumption reflects my belief that the supply of low-cost abatement in the South is not unlimited, and that development pressures in the South will push it to exceed its own emission permits in our abatement scenario. Thus, even if it is allocated 'excess permits' et the outset, the South may have difficulty in financing its requisite emission reductions via traceable permits because each 'excels' permit that it sells incurs an opportunity cost worth its own marginal abatement cost. For illustrative purposes, the permit price is assumed to settle at the South's marginal abatement cost plus half the difference between the North's and the Souths' marginal abatement cost in any year in the scenario.

Tradeable permits, Case 1
In Figure 6.4,1 show the high marginal cost curve from Case 1 in Chapter 5 in which the North and the South face the same shaped curve, but travel over it at different rates due to divergent required reduction ratios in each year.

In Case 1, both the North and the South pay the same $50/T-C abated until 1997, so I assume no trade in emission permits before this year. (It is as cheap for the North to reduce another tonne of carbon emissions as it is to buy a permit to emit that tonne from the South). But then the North moves up to $160/T-C abatement cost while the South remains at only $50/T-C abated until it too attains $160/T-C abated in 2002 when it reaches the 20 per cent required reduction ratio. From 1998 to 2002, therefore, I posit that the price of a permit to emit carbon will fall half way between the South's ($50) and the North's ($160) marginal abatement cost - that is, at $105/T-C emitted.


Figure 6.4 Tradeable permits transfer, Case 7

Sales fall to zero over the next two years as the cost curves have converged at $160. Then in 2004, the North moves rapidly up to a $250/T-C-y-1 abatement cost passing a required reduction ratio of 50 per cent. Consequently, the permit price increases to halfway between the North's own marginal abatement cost and that of the South ($160/T-C-y-1 abated) or $205/T-C emitted. As the South's cost never exceeds $160/T-C-y-1 abated in the rest of the scenario, the permit price does not change thereafter.

Having determined the permit price path, it is possible to derive the volume of permits that must be sold to finance the transfer annuity to the South. The volume of permits that generates a present valued stream of traceable permits sold at the posited, upwardly ratcheting permit prices that equals the transfer annuity of $34 billion is 280 million tonnes per year in each 'trading year' (see box, page 161). Relative to the North's average annual required reduction of 1.7 billion tonnes per year in our abatement scenario, Case 1 offers a plausible way to transfer resources to the South required to effect its abatement commitments.)

Tradeable permits, Case 3
Case 3 is a little more complicated as the North and the South are on different cost curves, but the principle is the same. The North's abatement cost is far below that of the South until 2004 when the North's required reduction ratio reaches 47 per cent and its abatement cost jumps to $294/TC-y-1 abated well above the South's $77/T-C-y-1 abated (which it never exceeds in the rest of the scenario). At the 'split the difference' permit price of $147/T-C-y-1 emitted, about 200 million tonnes of permitted emissions sold each year by the South to the North would fund the obligated annual transfer of $29 billion (see Figure 6.5). However, unlike Case 1, the underlying cost curves in Case 3 ensure that no trade occurs for the first decade, indicating that traceable permits may not set in motion a scheme that achieves transfers justified by the obligation-to-pay indice - an essential characteristic of a workable scheme.


Figure 6.5 Tradeable permits transfer, Case 3

Tradeable permit transfer, Cases 1 and 3

I. Tradeable permits, case i, high cost curve

Annuity of North-South transfer according to obligation-to-pay index, assuming
Nordhaus cost curve in all areas = 34 billion/year
phase 1:a North and South have same marginal abatement cost, no trade between 1995-1997
phase 2:a North buys South's abatement between 1998-2002 at $80/T-C abated
phase 3:a North and South have same marginal abatement cost, no trade between 2003-2004
phase 4:a North buys South's abatement between 1998-2002 at $205/T-C abated

Volume of sales to reach annuity of transfer according to South's obligation-to pay = 290 million T-C/year Net present value of sales at this level = 516 billion Annuity of sales at this level = 34 billion/year

II. Tradeable permits, case 3, medium cost curve in South, low cost curve in North/East

Annuity of North-South transfer according to obligation-to-pay index, assuming medium cost curve in South, low cost curve in North/East cost curve in all areas
= 29 billion/year

phase 1:a marginal abatement cost in North is less than in South, no sales by South to North
phase 2:a North buys South's abatement between 1998-2025 at $147/T-C abated

Volume of sales to reach annuity of transfer according to South's obligation-to-pay = 250 million T-C/year Net present value of sales at this level = 443 billion Annuity of sales at this level = 29 billion/year
a See Figures 6.4 and 6.5

These two cases demonstrate how the relative cost curves drive the hypothetical North-South trade in permits. It is likely that a big relative cost difference would impel massive innovation in carbon abatement technologies in the North if the South's abatement costs set the price of traded permits well above the North's marginal abatement cost. If the North's and South's marginal abatement costs are approximately equal, trade will be very slow. Either way, however, the fact that the North's marginal abatement cost eventually greatly surpasses that of the South suggests that buying permits from the South would become increasingly attractive to the North.

How exactly the market would operate and where the clearing price would settle would depend on the rate of innovation driving down the permit price, and the oligopolistic behaviour of the rent-seeking southern owners of the permits and monopsonistic behaviour of the rent-avoiding northern buyers.)

Emission abatement services

Another possible financing technique involves the South selling low cost abatement services to the North. This scheme assumes that the South has a large stock of inefficient energy-using equipment in its buildings, industries, and transport systems plus forestry related carbon fixing potential that exceeds its own responsibility to reduce emissions. This 'surplus' abatement potential endows the South with cheap abatement options relative to those in the North. Ironically, the highly wasteful energy economy of many southern states endows them with competitive abatement opportunities if an international market can be created for such activities.

Such services can be provided by private entities and do not require interstate agreement as is usually assumed to be required for traceable permit schemes. (Indeed, the first such project by a US utility which invested in carbon fixing reforestation in Guatemala, was led by private organizations.) Rather, it requires: (1) that abatement targets be adopted by states and that these states devolve responsibility to meet the abatement commitments onto public and private entities within these countries; and (2), that parties to the Convention adopt rules recognizing that abatement paid for by such an emission-reducing entity, but achieved at a saving relative to its own abatement costs in another country, can be debited from the emissions of the investor's country.

Here, I determine the volume of abatement services that would have to be sold by the South to the North to finance the South's incremental costs. Table 6.3 shows the calculation for the high and medium marginal cost curves used to calculate the transfers.

The abatement services market would be analogous to that in traceable emission permits. Polluters seeking a cheap abatement option relative to either the emission permit price or their own abatement cost would bargain with sellers of abatement services over the cost savings represented by their marginal abatement cost differential. However, abatement prices would be pegged to only this cost savings rather than the North's total marginal abatement cost. Thus, a smaller value is obtained by the South from the North for each sale of a tonne of carbon abatement versus a tonne of carbon permitted emission. Here, I posit that the abatement services price would settle at half the difference between the North's and the South's marginal abatement cost in our scenario.

In the high cost, Case 1- when the North and the South start out on the same cost curve - there is initially no cost difference, followed by a four year stretch of relative cost advantage to the South and a subsequent twenty year stretch of even greater advantage after 2005 (see Table 6.3).

Table 6.3 Abatement services transfer, Cases 7 and 3

A. CASE 1, HIGH MARGINAL COST TRANSFER OF 34 BILL $/Y Sale of Abatement Services to fund North's Transfer to South, and N-S transfer = l/2 price difference at time of sale

A1. Assume sale occurs when MCsth<MCnth, and transfer = 1/2 of versus North, with saving split 50:50 between North/South

A2. Annuity-OTP N-S Transfer = 34.0 Bill$/y

A3. Phase 1, no cost difference, no sale 0.0 $/T C, 1995-1997
Phase 2, transfer is 1/2 price cliff. 30.0 $/T C, 1998-2002
Phase 3 no cost difference, no sale 0.0 $/T C 2003-2004
Phase 4 transfer is 1/2 price cliff. 45.0 $/T C 2005-2025

A4. Required Sales to generate Annuity OTP? NPV trade 523.2 Annuity Trade 34.0 Sales volume = 1.2 BillT/y

A5. Total South Req Reduction is only 24.7 Bill T C 1995-2025
A6. Trade to fund total transfer 1995-2025 is 30 y x sales/y = 35.9 Bill T C 1995-2025
or 1.5 times South's required reduction over same period

B. CASE 3, MEDIUM MARGINAL COST TRANSFER OF 29 BILL $/Y
Sale of Abatement Services to fund North's Transfer to South, and N-S transfer
= 1/2 price difference at time of sale

B1. Assume sale occurs when MCsth<MCnth, and transfer = 1/2 of versus North, with saving split 50:50 between North/South

B2. Annuity-OTP N-S Transfer = 29.0 Bill$/y

B3. Phase 1, no cost difference, no sale 0.0 $/T C, 1995-2004
  Phase 2, transfer is 1/2 price cliff. 70.0 $/T C, 2005-2025

B4. Required Sales to generate Annuity OTP?

NPV trade 446.1
Annuity Trade 29.0
Sales volume = 1.0 Bill T/y

B5. Total South Req Reduction is only 24.7 Bill T C 1995-2025
B6. Trade to fund total transfer 1995-2025 is 30 y x sales/y = 30.0 Bill TC 1995-2025
or 1.2 times South's required reduction over same period

With the price trajectory specified, the volume of abatement services needed to fund the South's annual 'excels' incremental cost of $34 billion can be calculated. After discounting and annuitizing the volume of trade at the posited prices, the required sale of abatement services is no less than 1.2 billion tonnes per year. Thus, the South would have to find more than 150 per cent more abatement potential than its own required reduction at these relatively low costs over the thirty year scenario. Applied to the medium cost, Case 3, the same method demands only a slightly smaller volume of trade to achieve the smaller obligated funding in the South of $29 billion.

It is apparent that unlike traceable permits - and granted all the assumptions stated earlier as to the South's net profit earned on sale of abatement services the sale of abatement services cannot be relied on to finance the whole of the South's 'excess' incremental costs. It is highly unlikely that such large volumes of abatement opportunities exist in the South, abatement that must be achieved to the credit of other nations and over and above the reductions required on the South's own behalf. However, the forestry related carbon fixation opportunities in the South (either forestry maintenance or reforestation) may be much greater than those obtained by abating carbon dioxide from fossil fuel, and entrepreneurs may identify many new ways to provide competitive abatement services in the South.

I conclude that trade in abatement services - especially if supplemented by a scheme related to the South's forestry carbon fixation - would be useful within and between states in responding to emission limits or targets. Northern marginal abatement costs will also increase faster in the North than in the South as Northern states move up the required reduction curve calculated in Chapter 5 (see Figure 5.11). With each year that passes, therefore, it is likely that the price of traceable permits and abatement services will increase substantially, offering increasing opportunities for the South to reap benefits from their initial endowment of traceable permits that could thereby finance their own required reductions.

Using these instruments in combination to implement a global carbon reduction strategy may also be productive, as would introducing them at different phases of a strategy. Carbon taxes might be spent best at a national level, thereby stimulating a new wave of technological innovation and driving down the marginal cost of abatement for everyone. Trade in abatement services might be used effectively early on in a reduction strategy to enable the North to take advantage of lower marginal abatement costs in the South, even if the South has few or no excess permits. And traceable permits might be used later rather than earlier, thereby avoiding the possible perverse outcome that the South would self 'excels' emission rights at the outset of a reduction strategy to finance development that expands greenhouse emissions - which is what the world is trying to avoid.

Conclusion

I have shown that the incremental cost of abatement and coastal protection in the South that is justifiably the responsibility of the North is of the order of $30 billion per year. To these costs should be added a substantial sum for human resource development needed to realize the South's carbon abatement potential, perhaps as much again; plus approximately $100 million per year for technical assistance, training, and information provision (at least for the first five years of the Convention), and another $100 million for the costs of monitoring and verifying compliance with emission commitments by parties to the treaty (see Chapter 14).

These cost estimates are indicative and should be treated with caution. Because these figures are based on 'soft' estimates, these conclusions are not robust. They are based on many intervening assumptions and variables, changes in which would require radical revision in the numbers cited (see box). Many of the potential uncertainties may operate in opposite directions, thereby cancelling out each other. Some (such as marginal cost estimates and addition of non-CO2 greenhouse gases) may combine to enhance each other's effect on the incremental cost, increasing it dramatically.

Summary of uncertainties

• Present and future per capita carbon intensity (+20%)
• CO2 fossil fuel usage estimate error (5-10%)
• Aggregation errors
• Population projections (10%)
• Sink estimates (50%)
• Allocation rule for notional distribution of sinks (25-50%)
• 2025 permissible emissions target uncertainty (10-20%)
• Take-up rate of efficiency, substitution, renewables (10-20%)
• Cost of autonomous energy efficiency increase (20-50%)
• Levelized marginal cost schedules (differences of 100%) in current estimates; impact of 100% from innovation and diminishing returns on future cost ignored)
• Benefits (avoided coastal and agricultural costs) (25-50%)
• Discount rate (1-2% vs 5% vs 10%1
• Obligation to pay index used to determine the South's obligation (10% due to periodic readjustment)
• Treatment of non-CO2 fossil fuel greenhouse gases
• Trade impacts of abatement costs
• Intersectoral adjustment, human resource development, and institutional change costs

Note: author's estimates of the range of positive and negative uncertainty for variables is shown in ()

It is hard, however, to see that revisions will decrease the cost estimates provided here by a substantial amount. These estimates can be used reasonably as baseline figures of the likely magnitude of the financial flows involved in implementing the emission reduction commitments should the Climate Change Convention be successful.

The marginal abatement cost estimates, trade impacts, and human resource development costs are three particularly potent variables that need much more research before these estimates of incremental cost can be treated with confidence. It is also important that the emissions data base used in this chapter be updated and that the capital requirements be linked to a macroeconomic model that will enable the direct costs to be matched with indirect trade effects on the economic welfare of different nations and national groupings. Developing such a modelling capability to support policy making and the negotiations on the protocols of the Convention is of great importance.

Enough is known now, however, for action to start. Bilateral and regional activities can commence immediately (see Chapter 14). Indeed, such initiatives are a pressing priority as they would demonstrate the feasibility and logic of carbon taxes, traceable permits and abatement services.

Notes and references

1 See UN Development Programme, Human Development Report 1990, Oxford University Press, New York, 1990

2 See K Smith et al., Indices for a Greenhouse Gas Control Regime that Incorporate Both Efficiency and Equity Goals; report to Environmental Policy and Research Division, World Bank, Environment and Policy Institute, Honolulu, Hawaii, May 21, 1991; and Chapter 4 of this book

3 M Grubb, J Sebenius, A Magalhaes and S Subak, 'Sharing the Burden,' in I Mintzer (ed), Confronting Climate Change, Risks, Implications, and Responses, Cambridge University Press, New York, 1992, p 321

4 See T Hyder, 'Climate Negotiations The North/South Perspective,' in I Mintzer (ed), Confronting Climate Change, ibid, p 328

5 W Nitze, 'Criteria for Negotiating a Greenhouse Convention that Leads to Actual Emissions Reductions,' International Challenges, volume 11, no 1, 1991, p 15; see also A K N Reddy, 'Barriers to improvements in energy efficiency,' Energy Policy, December 1991, pp 953-961

6 World Resources Institute, World Resources, 1992-93, Oxford University Press, New York, 1992, pp 8; 236-7

7 G Piel, 'Agenda 21 A New Magna Carta,' Earth Summit Times, September 14, 1992, p 11

8 Scientists and technicians from UN Development Programme, Human Development Report, 1992, Oxford University Press, New York, 1992, p 190; population data from World Resources, World Resources, 1992-93, op cit (endnote 6), p 76

9 L Lunde, The North/South Dimension in Global Greenhouse Politics, Conflicts, Dilemmas, Solutions, Report 9, Fridtjof Nansen Institute, Lysaker, Norway, 1990, p 17

10 Table 1475, US Department of Commerce, Statistical Abstract of the United States, recent annual editions, Washington DC

11 See the survey in S Barrett, 'Economic Instruments for Global Climate Change Policy', London Business School for Environment Directorate, OECD, Paris, 1990; a more accessible version is found in Barrett's 'Global Warming, The Economics of a Carbon Tax,' in D Pearce (ed), Blueprint 2, Greening the World Economy, Earthscan Books, London, 1991, pp 38-39. See also Price Waterhouse Government Liaison Services, Consultancy Report to Department of Arts, Sport, The Environment, Tourism and Territories on Carbon Tax, Canberra, ACT, June 1991

12 For a summary of eight carbon tax studies, see S Barrett, 'Global Warming, The Economics of a Carbon Tax,' in D Pearce (ed), Blueprint 2, ibid, pp 38-39

13 See J Epstein and R Gupta, Controlling the Greenhouse Effect: Five Global Regimes Compared; Brookings Occasional Papers; The Brookings Institution, Washington, DC, 1990; D Victor, 'Limits of market-based strategies for slowing global warming: The case of traceable permits', Policy Sciences, volume 24, 1991, pp 199-222; A Markandya, 'Global Warming, The Economics of Tradeable Permits,' in D Pearce (ed), Blueprint 2, op cit (endnote 11), pp 53-62

14 For reviews of this experience, see E Meidinger, 'On Explaining the Development of 'Emissions Trading' in US Air Pollution Regulation', Law and Policy, volume 7, no 4, October 1985, pp 447-477; and T Tietenberg, 'Transferable Discharge Permits and the Control of Stationary Source Air Pollution: A Survey and Synthesis'; Land Economics, volume 56, no 4, November 1980, pp 391416

15 M Grubb and J Sebenius, Participation, Allocation and Adaptability in International Tradeable Emission Permit Systems for Greenhouse Gas Control, forthcoming in OECD workshop proceedings on greenhouse gas traceable permits, Paris, June 1991, p 4.

16 J Swisher and G Masters, International Carbon Emission Offsets: A Tradeable Currency for Climate Protection Services, Technical Report309, Department of Civil Engineering, Stanford University, Stanford, California, 28 February 1989

17 Joel Swisher, personal communication, June 22,1992

18 W Makundi et al provide detailed estimates of current, committed and delayed carbon uptake and emissions in southern forests in Carbon Emissions and Sequestration in Forests: Case Studies From Seven Developing Countries, Lawrence Berkeley Laboratory, LBL-32119, UC-402 (draft), August 1992

19 See J Swisher and G Masters,'A Mechanism to Reconcile Equity and Efficiency in Global Climate Protection: International Carbon Emission Offsets,' Ambio, volume 21, no 3, April 1992, pp 154-159