The short answer to this FAQ made three points:
- The problem: Emission are a global negative externality.
- Individual caps don’t fix it.
- A global carbon price does.
1. The real problem is the global externality problem
Everyone complains about this “externality,” but no one does anything about it. National caps ignore it an may even make it worse. The “externality” diagnosis is so common that it has many names:
- Climate is a problem of the global commons.
- Emissions are a global negative externality problem.
- Emissions cause a free-rider problem.
- Abatement is a global public goods problem.
They all mean the same thing. But why is it identified as “the climate problem.” What about coal-fired power plants? The point is, we build too many because of the externality problem.
To see that free-riding truly is the essence of the climate problem, imagine that nations could not free-ride. Then their emissions would only change their own climate. There would be no need for UN climate conferences, Kyoto agreements or Copenhagen accords. If the US emitted too much, it would hurt only itself, and the US Congress would have reason enough to act. There would be no sense in international negotiations over policies that are purely national.
This point is most fundamental. The international climate problem is purely a free-rider problem.
2. Why national caps do nothing for the free-rider problem
Without a cap, the US can cut its emissions, but the benefits will mostly be external — they will go to other countries. But the US could pick a cap and set it low to “make itself” cut emissions. Then the benefits would still mostly go to other countries . The cap is merely a public announcement of how nice a country has chosen to be — unless there is international emissions trading.
So what is the effect of cap-and-trade? If the US cuts emissions more than its cap, then it can sell its extra permits to other countries and make money. And if its cap is so tight that it fails to cut emission enough, it will have to pay other countries when it buys emission permits from them. So the trade part has two effects: (1) it makes a country want to set a high cap, and (2) it makes it want to emit less — if all the other countries have been nice and set their caps low so that they need permits and are willing to pay for them.
International cap-and-trade is a crazy game, and it is nothing like national cap-and-trade, where the government set the caps. In the international game, the coal plants (countries) set their own caps. Not surprisingly, game theorists have analyzed this and it doesn’t work. Countries set high caps to win the game, because setting a high cap (just like emitting CO2) helps them and mainly hurts everyone else. If the price is $50/t and a country raises it cap by 1 billion tonnes, it will be $50B/year richer, and the rest of the world will be $50/year poorer. Caps just monetize the climate externality.
International cap-and-trade just changes the game from the emissions free-rider problem to the high-cap free-rider problem. And that’s exactly what Kyoto proved. Of course, in either game — with caps or without, there will be a few nice players, but they will be the same ones either way.
As Weitzman says, a global price “embodies a countervailing force against narrow self interest.” This is because it is not just a national price, it’s a global price. So if any country tries to benefit by reducing the price so it can emit more, it will find that this automatically causes all others to emit more, to the country’s detriment.
This is not the perfect antidote, but it is quite close. The perfect antidote would be to make all of the global warming caused by country A concentrate on just country A. Instead, a global price makes all countries, in effect, retaliate when A misbehaves. Let’s see how that works in a simple world with 10 identical countries.
Suppose the price is $100 and that’s ideal. But country A decides it can do better by demanding the global price be dropped to $10. It will emit more at a lower price, and this will cause climate damage world wide. Say the total damage is $10 trillion. It will only suffer $1 trillion of that damage, so if no one retaliates, it will find the savings from less abatement to be worthwhile.
With no externality problem it would suffer the full $10 trillion in damage, and since $100 is ideal we know that the fear of this damage would make it choose to keep the price at $100.
But what happens in a world with an externality problem and a global price? In this world, when the price is lowered to $10, every country emits more and they each cause $10 trillion in damage. In each case their damage is spread over all others. So country A will find it receives $1 trillion in damage from each country (including itself). So in this world, the global price makes country A‘s actions affect itself exactly like the externality problem had vanished, and it felt the full impact of its own emissions.