An Economic Analysis of the Kyoto Protocol - Alexis Manning
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An Economic Analysis of the Kyoto
Protocol
Alexis Manning
I. Introduction II. Background
G
lobal climate change represents a serious im Global climate change results, according to a
pending issue that must be addressed in the widely accepted scientific consensus, from the accu-
present, not the distant future, in order to mulation of GHG’s in the atmosphere, which absorb
avoid irreversible, adverse consequences. Due to ex- infrared radiation, causing global temperature to rise.
ternalities—intertemporal and locational—markets will Scientists hypothesize with a considerable amount of
not reach an efficient outcome. Present generations evidence that the burning of fossil fuels, which emit
bear the cost of reducing greenhouse gas (GHG) emis- carbon dioxide (CO2), contributes to the increasing
sions and do not experience the negative repercus- concentrations of GHG’s in the atmosphere and,
sions of global climate change, while future genera- therefore, creates global climate change (Rao, 2000).
tions reap the benefits of avoiding global warming with- The exact effect of increasing average global tem-
out enduring the initial monetary peratures remains uncertain, but
cost of emission reductions. Also, “The Kyoto Protocol ne- simulations project rising of the sea
since the stratosphere is a public level, unstable weather patterns,
glects economic as well
good for the entire world, the free extension of climate-sensitive dis-
rider problem occurs on a global as scientific realities, and eases, and disruption of agricultural
scale (Rao, 2000). Each country therefore, qualifies as a productivity (Chandler, 1999).
has an enticing incentive to allow fundamentally flawed The scientific community predicts
other nations to reduce GHG emis- treaty.” that the mean global temperature
sions without contributing to emis- will rise 3°C to 4°C over the next
sion reduction efforts themselves. century if GHG emissions continue
Due to these inevitable externalities, government in- to increase unabated (Easterbrook, 2001).
tervention and international cooperation is not only Considering the potential for drastic, irrevers-
justifiable but a necessity. ible consequences, international policy should reflect
The Kyoto Protocol reflects an attempt to the precautionary principle, which implies society is
correct these externalities by imposing GHG emis- risk-averse and ensures against the possibility of a
sion reduction standards upon current generations, global warming catastrophe (Kellow, 1998). There-
thereby combating global climate change. Unfortu- fore, despite the lack of complete scientific evidence,
nately, this treaty fails to present a valid solution to global warming represents a formidable threat to hu-
global warming. The Kyoto Protocol neglects eco- man welfare and merits global action.
nomic as well as scientific realities, and therefore, As a result of this growing, widespread con-
qualifies as a fundamentally flawed treaty. Neverthe- cern of global climate change, developed nations met
less, global warming represents an inevitable, formi- in December of 1997 and formed the Kyoto Proto-
dable threat to human welfare that merits a pro-ac- col, a treaty intended to counteract the trend of glo-
tive approach characterized by efficiency, cost-effec- bal warming by instituting legally binding GHG emis-
tiveness, flexibility, and equitability. sion reduction standards. Under the Kyoto Proto-
col, Annex I nations, which encompass 39 high in-
79 The Park Place Economist Volume XAlexis Manning
come, developed countries, must reduce their emis- Nordhaus (1998), a complete international emission
sions of six GHG’s, including CO2, methane, nitrous reduction trading system could reduce the massive
oxide, hyrdoflorocarbons, polyflorocarbons, and sul- cost of Kyoto by a factor of nine. However, a trad-
fur dioxide by an average of 5% from 1990 levels. ing system restricted only to Annex I nations produces
The treaty stipulates that this reduction occur during a less impressive decline in cost, and reduces the to-
the commitment period extending from 2008-2012. tal cost of Kyoto by less than a factor of two. Clearly,
The Kyoto Protocol will become effective once 55 a globally inclusive trading system could achieve GHG
participating parties, representing at least 55% of CO2 emission reduction goals in a more cost efficient man-
emissions, ratify the treaty (Rao, 2000) ner, thereby lessening the financial burden of Kyoto.
In addition, the international emission reduc-
III. Benefit-Cost Analysis of the Kyoto tion trading system could drastically impact individual
Protocol economies. Due to the increasing costs of produc-
Despite the treaty’s many flaws, the Kyoto tion in Annex I countries, companies may elect to shift
Protocol allows several innovative, theoretically cost- production to developing nations, which will have a
effective approaches to attaining the emission reduc- substantial lower MC of production. This shift will
tion quotas instead of relying upon the standard com- negate Kyoto’s efforts to reduce global GHG emis-
mand and control approach. Unfortunately, many of sions, because firms will be able to pollute freely in
these strategies remain dangerously vague, and the these non-Annex I nations. Goods produced in An-
treaty compromises economic theory in favor of poli- nex I nations will become more expensive, while non-
tics. In theory, the Protocol permits a considerable Annex I goods will become comparatively less ex-
amount of flexibility in achieving these emission re- pensive. Consequently, Annex I nations will experi-
ductions. This flexibility, in turn, could greatly reduce ence a comparative disadvantage. Also, these per-
the total cost of obtaining the desired emission reduc- mits may discourage development in certain coun-
tions. However, in practice, potentially flexible mecha- tries. Russia and Eastern Europe will possess an ex-
nisms become inflexible due to restrictions and regu- cess of emission reduction credits due to the collapse
lations (Tol, 1998). of the Soviet Union that occurred after 1990 (Tol,
The treaty allows an international emission 1998). Consequently, these countries will experience
reduction trading system, which creates a limited glo- a windfall and reap unearned profits. These coun-
bal market for emission reduction units among Annex tries will benefit more from selling emission reduction
I countries (Rao, 2000). Countries with a lower mar- permits than developing efficient, environmentally
ginal cost (MC) of reduction will reduce their emis- friendly policies. Consequently, total output will de-
sions and sell their excess emission reduction credits crease significantly, though their income will actually
to countries with a higher MC of reduction. There- increase due to large transfers from Annex I countries
fore, MC’s will equalize; countries will engage in mu- (Nordhaus, 1998). Although their GDP may reflect
tually beneficial transactions to achieve emission re- prosperity, the reduction of output has serious impli-
ductions in the most cost effective method possible. cations for their economy.
The existence of tradable emission reduction units Kyoto also permits other methods of achiev-
potentially could drastically reduce the total cost of ing GHG emission reductions. Through “joint imple-
Kyoto’s standards. mentation,” Annex I countries can achieve their emis-
However, considering that Kyoto only legally sion reduction quotas by undertaking projects in other
obligates developed nations to alter GHG emissions, Annex I countries to reduce GHG emissions (Chan-
the treaty limits permit trading to Annex I nations (Rao, dler, 1999). However, the MC of reductions lack
2000). Since most Annex I countries have relatively significant variability among these nations, and this strat-
similar MC’s of emission reduction, the benefits of an egy will not radically mitigate the costs of Kyoto. In
international trading system cannot be fully realized. addition, the treaty provides Annex I nations with the
Although this theoretically cost effective system dem- opportunity to fulfill emission reduction requirements
onstrates a less expensive method than a standard in developing nations, under the “clean development
command and control approach, this diluted permit mechanism” (CDM). The MC of reduction is signifi-
trading system will not approach the least cost cantly lower in developing nations that will allow de-
method. According to a study conducted by William veloped nations to capitalize off these lower cost op-
The Park Place Economist Volume X 80An Economic Analysis of the Kyoto Protocol
portunities. Developed nations can undertake projects widely accepted projections, China will surpass the
in developing nations, which will reduce emissions, US as the largest CO2 emitter by 2015, and the de-
while encouraging technological innovation and eco- veloping world will overtake the developed world in
nomic development in these underdeveloped areas CO2 emissions by 2020 (Tol, 1998). Therefore, the
(Chandler, 1999). Kyoto also actions of 39 Annex I nations
allows emission reduction flex- “...the US composes only cannot significantly counteract
ibility, because the treaty allows the trend of global climate
5% of the world population
countries to achieve emission change, while 134 non-Annex I
reduction credits through refor- yet accounts for 30% of nations continue to exponentially
estation. Forests qualify as emis- CO2 emissions.” increase GHG emissions
sion reduction units, because (Nordhaus, 1998). Any
they are CO2 “sinks,” which absorb CO2 and prevent progress accomplished by developed nations will be
GHG’s from entering the stratosphere. Therefore, more than offset by increasing emissions of develop-
the presence of forests can significantly mitigate glo- ing nations. According to Nordhaus, Kyoto will only
bal climate change (Sutherland, 2000). decrease global mean temperature by 0.13°C from
Kyoto contains several innovative approaches the projected baseline temperature increase during
to combating global climate change that encourage the next century. This insignificant decrease in aver-
flexibility, thereby lowering total costs. However, the age global temperature cannot mitigate the global
Protocol states many of these emission reduction warming trend. Therefore, the Kyoto Protocol lacks
mechanisms in very vague terms and limits the use of scientific validity. Kyoto cannot possibly achieve its
these alternative methods. Regardless of varying MC ultimate goal of reversing the global climate change
of reduction, international efforts and reforestation trend.
projects may only supplement domestic efforts In addition, the chosen emission reduction
(Nordhaus, 1998). Therefore, the Kyoto Protocol targets lack any scientific or economic foundation.
will not achieve an efficient outcome. The Protocol stipulates that each Annex I nation re-
Perhaps the most fundamental flaw of Kyoto duce GHG emissions by an average of 5% from 1990
involves the lack of mandatory participation of devel- levels. These historical baseline targets lack any rela-
oping nations. The treaty fails to impose legally bind- tion to global CO2 concentrations, projected tempera-
ing emission reduction standards upon Non-Annex I ture increases, or MC of emission reduction (Kellow,
countries, which encompass 134 developing nations 1998). The Kyoto Protocol sets completely arbi-
(Tol, 1998). Some proponents of Kyoto argue that trary emission reductions quotas, which prevent an
the developed world, specifically the US and Europe, efficient, effective outcome. Efficient emission reduc-
pioneered the use of fossil fuels during industrializa- tion standards would reflect economic and scientific
tion and therefore, created the current global warm- factors, including GHG concentrations and MC’s of
ing predicament. Also, developed nations account emission reduction.
only for 20% of the global population yet emit 60% Also, the impending emission reduction tar-
of the world’s CO2 emissions (Easterbrook, 2001). get deadlines approach economic and scientific im-
Even more alarming, the US composes only 5% of possibility. Kyoto requires the US to reduce GHG
the world population yet accounts for 30% of CO2 emissions by 7% of 1990 levels. According to pro-
emissions. According to per capita calculations, a jections, if emissions continue to increase at the cur-
Chinese person generates 1/10 of the GHG emis- rent rate, the US will be over 20% above 1990 CO2
sions of an American. Nevertheless, even the most levels by 2008 (Tol, 1998). Consequently, the US
ardent supporters of Kyoto admit that the treaty can- must reduce it emissions by 27% of its projected level
not stabilize GHG emission without meaningful par- in less than a decade. The European Union (EU)
ticipation of developing countries, which represent faces similar, though not quite as daunting, emission
80% of the global population (Tol, 1998). reduction challenges as the US. The next few years
As developing nations advance, their GHG do not constitute sufficient time to institute such dras-
emissions will rapidly increase due to industrial de- tic emission reductions.
velopment, which relies heavily upon high CO2 emit- The presence of relatively uniform emission
ting fossil fuel sources, including coal. According to reduction standards, without the mitigating presence
81 The Park Place Economist Volume XAlexis Manning
of significant market incentives, creates very cost in- the US’s GDP annually (Murkowski, 2000). Imple-
effective results. Standard emission reductions among menting Kyoto will cause serious economic ramifica-
Annex I nations neglect to consider the individual cir- tions. By 2050, the US will transfer over $40 billion
cumstances of each country under the guise of equal- annually to Russia and Eastern Europe to purchase
ity. Kyoto ignores factors which significantly affect a emission reduction permits (Nordhaus, 1998). This
nation’s ability to reduce domestic emissions, includ- large transfer of wealth will deplete funds for capital
ing level of wealth, population growth rate, type of investment within the US and discourage domestic
energy supply, transportation system, rate of economic growth of the economy.
growth, past investment selections, and existing infra- In addition, energy prices will dramatically
structure (Kellow, 1998). For example, the treaty increase. In order to achieve Kyoto’s emission re-
allows Eastern Europe, as well as nations included in duction standards domestically, the US will need to
the former Soviet Union to benefit from their histori- decrease energy consumption by raising prices, which
cally incredibly inefficient energy systems by using will eventually decrease demand. However, the in-
1990 levels as a baseline (Nordhaus, 1998). These elastic demand for energy predicts that prices must
countries could easily reduce emissions at a minimal drastically increase before consumers respond. En-
cost. Also, the collapse of the Soviet Union, which ergy prices will increase by 33% by 2010. Imple-
greatly affected industry and therefore, reduced GHG menting Kyoto will impose a tax on carbon exceed-
emission from 1990 levels, allows Russia a huge wind- ing $250 per ton by 2050 (Nordhaus, 1998). Kyoto
fall. Russia would be able to meet its target without will consume an average of $2,728 of household in-
any modifications of its current emission level. come annually, eradicate 2.4 million jobs, and de-
Also, enforcement of the Kyoto Protocol re- crease the US living standard (Murkowski, 2001).
mains a perplexing, unresolved problem. Due to the Proponents of the treaty argue that the high
extremely high projected cost of Kyoto, countries will costs of global climate change justify the extremely
have a strong incentive to cheat. As a result, high large price tag of the treaty. Although the estimated
transaction costs to ensure en- total cost of unabated global cli-
forcement will add to the al- “...enforcement of the Kyoto mate change varies, relatively
ready burdensome cost of Protocol remains a perplexing, conservative estimates total
Kyoto. The treaty fails to ad- unresolved problem. Due to $1.8 trillion, which clearly vali-
dress the specifics of enforce- the extremely high projected dates the devotion of resources
ment and consequently, pun- cost of Kyoto, countries will to combat this environmental
ishment. Even more problem- problem. However, as stated
atic, there is no precedence for
have a strong incentive to earlier, Kyoto does not effec-
a global enforcing agency of the cheat.” tively mitigate global warming.
magnitude Kyoto requires. Doubts arise as to the Kyoto’s benefits only total $0.12 trillion, while the
practical possibility of implementing and enforcing costs total more than $0.8 trillion. Therefore, the
Kyoto. Kyoto Protocol clearly fails the benefit-cost test; the
More than any other factor, the unbelievably benefit-cost ratio equals 1/7 (Nordhaus, 1998). The
high cost of implementing Kyoto effectively eradicates Kyoto Protocol is an extremely inefficient, cost inef-
any possible value of the treaty. Nordhaus estimates fective approach that fails to produce results.
the global cost of Kyoto to total $828 billion (1998).
Annex I nations bear this economic burden, while non- IV. Conclusion
Annex I countries benefit, albeit comparatively insig- Although the dynamics of global climate
nificantly. Eastern Europe and Russia emerge as ben- change necessitates both government intervention and
eficiaries. However, these gains are merely transfers international cooperation, the Kyoto Protocol lacks
from the US, due to the tradable emission reduction the ability to counteract the global warming trend but
credits, and do not represent true economic benefits. retains a prohibitively high price. Both the economic
If implemented, the US will bear the brunt of and ecological ramifications of Kyoto raise concern.
Kyoto’s massive cost, paying over 2/3 of the total Implementing Kyoto would result in both economic
global cost, which reaches approximately $517 bil- and ecological disaster. Kyoto would cause an in-
lion (Nordhaus, 1998). The treaty requires 2-5% of credible amount of strain upon the US and other An-
The Park Place Economist Volume X 82An Economic Analysis of the Kyoto Protocol
nex I economies. In addition to the inevitable eco- Fortunately, the US faced economic and sci-
nomic crisis, the global climate change would con- entific realities, and President George W. Bush termi-
tinue to occur at an alarming rate, aiding a possible nated Kyoto Protocol negotiations in March of 2001.
ecological disaster. However, the world would lack However, many Annex I nations remain in the nego-
necessary resources to devote to combating global tiations. Although some environmentalists and politi-
climate change due to the high costs of Kyoto. Ironi- cians view the US’s rejection of the treaty as short-
cally, implementing the Kyoto Protocol, a treaty de- sighted and ignorant, the rejection of Kyoto appears
signed to reduce global warming, would actually in- logical and prudent, in terms of both the short and
crease the severity of this environmental problem, long run. Allocating additional resources to Kyoto, a
because large quantities of valuable resources would profoundly flawed treaty, would represent waste of
be devoted to a fundamentally, flawed, ineffective limited, valuable resources. The US now possesses
treaty. Kyoto imposes a large opportunity cost upon the opportunity to pursue an economically and scien-
the world. The financially depleted world would lack tifically valid alternative to the Kyoto Protocol. As
the necessary resources to solve global climate change. the largest CO2 emitter and an influential world power,
Achieving an efficient global climate change the US has an obligation to take a pro-active stance
policy is a very challenging goal, but several funda- towards climate stabilization in order to ensure the
mental guidelines exist. Global climate change ne- welfare of future generations across the globe.
cessitates decisive global action. Each country will
not individually elect a globally optimal policy, be- References
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the proper incentives for participation, which implies An Economic Analysis of the Kyoto Protocol.” Yales Cowles
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plete efficiency. Nevertheless, global warming poli-
cies should strive towards efficiency. Flexibility in
achieving reductions in GHG emission will lessen the
cost of implementing the policy and result in a more
efficient outcome. International tradable emission
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