EC2A1 PROJECT

The Kyoto Protocol and the search for Pareto Improving Policies in the Presence of Negative Externalities

Gabriel González | LSE BSc Economics

EC2A1 WT 2024

The Kyoto Protocol - An attempt to curb carbon emissions.

- Proposed by the United Nations Framework Convention on Climate Change (UNFCC). - Currently adopted by 192 countries (UN, 2024).- Major stakeholders such as Canada and the US withdrew.-Sought to create a Carbon Trading system between participants.

Canadian Politician Jack Layton at the 1997 Kyoto Protocol Convention (Britannica, 2024)

Utility Maximization in the Presence of Externalities - Setting up our Model

Treating Global Emissions as Exogenous

Model Assumptions

Agents treat carbon (y) as a good with strictly positive, but diminishing marginal utility. They disregard their contributions to climate change in their optimization problem.

1. Rich country (A) has N people where each individual inelastically produces w units of carbon/fossil fuels -y.
2. Poor country (B) has M people where each individual inelastically produces 1 unit of a composite good - x.
3. Both countries make consumption decisions with respect to Cobb Douglas (convex) preferences.
4. Their experienced utility decreases with global carbon consumption, which they contribute towards.

Welfare Theorems

1) First and Second Welfare Theorems fail due to the presence of carbon externality.2) Pareto improving policies were favored by the UNCC to make it more appealing for countries to ratify the treaty.

State Contingent Income Diagram (Source: EC1A1 Lecture Slides)

Adam Smith - said to be the first economist to verbally formulate the welfare theorems.

Roadmap of our Analysis

Why did the Kyoto Protocol Fail?

Potential Extensions to the Model - Game Theory and Nordhaus' DICE Model

A Pareto improving Policy attenmpted by the Kyoto Protocol

The applicability of the Coursework's Model in the Kyoto Protocol

Pareto Disimproving Policies and their effect on signatoire decisions.

How well does the General equillbrium model proposed by the Coursework model climate change externalities?

What other policies does the current academic literature favor in this dilemma? Why are Cap and Trade schemes Pareto Imrpoving?

What type of general equillibrium models is the current academic literature formulating to predict the effects of climate change?

The applicability of the Coursework's Model in the Kyoto Protocol

1, 2: "By 2030, the direct health costs of climate change are estimated to be between $2 and 4$ billion a year" (UN, 2024). 3, 4: "GDP per capita and population growth remained the strongest drivers of CO2 emissions from fossil fuel combustion in the last decade" (Intergovernmental Panel on Climate Change, 2022). 5: Perhaps increased productivity causes increased innovation in non polluting technologies? Or perhaps increased productivity increases the number of fossil fuel extraction facilities?

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Are people really unaware of their marginal contributions towards Climate Change?

80% of OECD countries believe that their country should act to mitigate the effects of climate change, and that they themselves are taking actions at home to abate carbon emissions (Clean Energy Wire, 2023). Under no strictly marginal increasing utility with respect to Ya, MU can be negative, so agents would autoregulate consumption of carbon (under the assumption that carbon supply is not inelastic, and is responsive to aggregate demand).

(Yale Program on Climate Change, 2024)

How can enacting carbon production restrictions be Pareto Improving?

(The Economist, 2023)

• w is the rich country's productivity parameter.
• Higher w means higher production of carbon. Our model assumes that supply is perfectly inelastic, so in equillibrium carbon production is Nw.
• Utility increases for group A because the "marginal cost to society" of carbon production is higher than the "private benefit" from carbon consumption.
• A people loose income and utility from decreased productivity and income, but regain this income as carbon becomes scarcer and its good increases.

Restricting Carbon / Taxing Production? Politically feasible?

In "The Relative Efficiency of Voluntary vs Mandatory Environmental Regulations" by Wu and Babcock (1999), the authors argue that within the context of environmental regulations, voluntary schemes may lead to higher levels of compliance than mandatory schemes.

(Ed Gamble, 1990)

A true Pareto improving Policy attenmpted by the Kyoto Protocol - Cap and Trade Schemes

• Chichilinisky and Hammond (2016) prove that a cap and trade scheme is a pareto improving policy.
• Cap and trade schemes do not reduce total emissions, but make it more appealing for countries to join climate change treaties than beforehand.

• "The number of emissions trading systems around the world is increasing. Besides the EU emissions trading system (EU ETS), national or sub-national systems are already operating or under development in Canada, China, Japan, New Zealand, South Korea, Switzerland and the United States."- European Commission.

Why did the Kyoto Protocol Fail?

To meet the targets under Kyoto for 2012 would be the equivalent of ... the transfer of $14bn (£8.7bn) from Canadian taxpayers to other countries – the equivalent of $1,600 from every Canadian family – with no impact on emissions or the environment,"

-Peter Kent, former Canadian Minister of the Environment

Penalties as Pareto Disimproving Policies

- Radner et al. (2004) analyzed Nash Equillibria in "self-enforcing climate change treaties" through a dynamic game with sovereign nations. -They conclude the Kyoto Protocol failed to establish effective sanctions to incentivize compliance with the treaty.

The forefront of research in Climate Change General Equillibrium Models

References

2023, 27 Nov, et al. “Global Surveys Show People’s Growing Concern about Climate Change.” Clean Energy Wire, 27 Nov. 2023, www.cleanenergywire.org/factsheets/global-surveys-show-peoples-growing-concern-about-climate-change. Adar, Z., et al. “The Relative Efficiency of Voluntary vs Mandatory Environmental Regulations.” Journal of Environmental Economics and Management, Academic Press, 25 May 2002, www.sciencedirect.com/science/article/abs/pii/S0095069699910756. “Climate Change.” Population Matters, 22 Dec. 2023, populationmatters.org/climate-change/. “EU Emissions Trading System (EU ETS).” Climate Action, climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets_en. Accessed 6 Mar. 2024. “Kyoto Protocol.” Encyclopædia Britannica, Encyclopædia Britannica, inc., 25 Jan. 2024, www.britannica.com/event/Kyoto-Protocol. Nordhaus, William. “Evolution of Modeling of the Economics of Global Warming: Changes in the Dice Model, 1992–2017 - Climatic Change.” SpringerLink, Springer Netherlands, 17 May 2018, link.springer.com/article/10.1007/s10584-018-2218-y. “Taking Action for the Health of People and the Planet.” United Nations, United Nations, www.un.org/en/climatechange/science/climate-issues/health#:~:text=And%20by%202030%2C%20the%20direct,risk%20factors%20for%20mental%20health. Accessed 6 Mar. 2024. Unfccc.Int, unfccc.int/kyoto_protocol#:~:text=In%20short%2C%20the%20Kyoto%20Protocol,accordance%20with%20agreed%20individual%20targets. Accessed 6 Mar. 2024. “Yale Climate Opinion Maps 2023.” Yale Program on Climate Change Communication, 1 Mar. 2024, climatecommunication.yale.edu/visualizations-data/ycom-us/.