Designing Climate-Change Treaties

1. Designing Climate-Change Treaties E. Maskin Institute for Advanced Study

2. probably can’t deal successfully with climate change without strong international treaty limiting greenhouse gas emissions • but getting treaty not easy • we all benefit from emission reductions • but such reductions are economically costly • each country would like others to reduce • so, free-rider problem

3. Also, fairness and efficiency problems • rich countries got rich by emitting carbon dioxide • so why not poor countries too? • reductions costlier for poor countries • So fairness and efficiency suggest • poor countries should make smaller reductions than rich countries

4. But how should reductions for each country be determined? • Answer: by international treaty • Most likely: treaty will be cap-and-trade system • each country given a cap on emissions • can “buy” additional emissions or “sell” excess emissions

5. If countries’ costs of reductions known, then could calculate appropriatecaps and obtain treaty that benefits all countries • But, though each country likely to know its own costs reasonably well, knowledge not publicly available • So, information crucial for calculating caps is missing

6. Mechanism Design can help • shows how to achieve social goals when critical information not publicly known • in this case: social goals = right caps • Let’s look at simple example

7. 2 countries: rich and poor • rich country’s cost of emission reduction x: • Suppose want over-all reduction of 10 • efficient reductions solve problem

8. Assume • Then efficient reductions are as follows:

9. How can we achieve these reductions? • Must give countries incentive to “reveal” costs • Suppose poor country given trade concession from rich country contingent on what countries say their cost parameters are: t (3,9) = concession if rich country says 3 poor country says 9 • Similarly, for t (3,3), t (1,9), t (1,3)

12. to satisfy all inequalities? • Yes. • for example, take t (3,9) = t (1,9) = 0 t (1,3)= 4 t (3,3) = 32 • Thus can solve treaty-design problem even though we don’t initially have critical information

13. Designing carbon-reduction treaties • important, but difficult • mechanism design theory can help