Faculty member in the Department of Managerial Economics & Decision Sciences until 2013
“Half of something is better than all of nothing” goes an old adage. And for the past two decades, that is how the world’s leaders have approached climate change negotiations. From regional accords to the Kyoto Protocol, each agreement has been a baby step toward the more ambitious goal of a long-term, global approach to climate change. But while compromises make these smaller agreements possible, one aspect of a successful global climate treaty may not be open to debate. According to research by Bard Harstad, associate professor of managerial economics and decision sciences at the Kellogg School of Management, the length of an agreement should be a long-term-or-nothing proposition.
“Short-term agreements can be even worse” than no agreement at all, Harstad says, “because investments may decline if countries anticipate frequent negotiations.” His findings were consistently clear—it did not matter whether emissions were restricted by cap-and-trade, caps without trade, or a carbon tax. But the findings run contrary to prevailing economic thought. “Many economists recommend short-term agreements because you don’t know how much is optimal to pollute in the future,” he says. With short terms, countries can adjust their strategies accordingly, many economists argue. But with short-term agreements, negotiations are always on the horizon so countries delay investments to improve their bargaining positions, according to Harstad. Those countries who invest in clean technologies early will be expected to make further cuts since they have the capacity to do so, placing them at a disadvantage in the next round of negotiations.
Denmark has already been put in this unenviable position. At a European Union summit in 2008, Poland, Bulgaria, and other Eastern European states called on Denmark—who is heavily invested in renewable energy—and other Western European nations to grant them concessions. Eastern Europe was falling hopelessly short of their targets due to their reliance on coal. Denmark’s lead in renewable energy was an advantage, the Eastern bloc countries claimed, and as a result Denmark should trim its emissions further.
Denmark’s problem stemmed from the summit agreement’s early expiry date, Harstad says. The accord required nations to cut their emissions 20 percent below 1990 levels by 2020, a mere twelve years from the negotiation date. While twelve years may seem like an eternity to stock traders, it is a heartbeat to investors in large capital projects such as wind farms and solar installations. To see their investments pay off, they would need a measure of certainty beyond 2020. Lacking certainty, governments and private investors prefer to sit on the sidelines.
Fine-tuning the Terms
The solution, Harstad says, is to adjust the other conditions accordingly. If a long-term agreement cannot be reached, then emissions limits must tightened. “To encourage more investments, a short-term agreement must be more ambitious—it should specify lower pollution levels.”
The brief duration of current climate treaties is not the only thing holding back progress. Agreements that expire without replacement, such as the Kyoto Protocol, are also complicit. Here climate negotiators could learn a lesson from their partners in international trade, Harstad says. “When the Doha Round negotiations broke down, it was not the case that we reverted to noncooperative laissez-faire.” Instead, trading terms reverted back to the previous agreement, the Uruguay Round. Negotiated between 1986 and 1994, it transformed the General Agreement on Trade and Tariffs into the World Trade Organization, a monolithic organization that oversees nearly all global trade to this day.
“Maybe the most important lesson is that we have something to learn from trade,” Harstad notes. “If one trade negotiation round fails, they don’t revert back to no agreement, they revert back to an existing set of agreements. That’s a better way of negotiating.” Climate compacts that retained their authority when new negotiations failed would motivate countries to seek better terms and update the agreement, Harstad maintains.
Intellectual Property Rights and Climate Treaties
Unfortunately, adopting a model similar to international trade agreements may not be a simple task. Politicians will likely balk at an agreement that could—barring any successful replacements—remain on the books indefinitely. Furthermore, negotiating the role of intellectual property rights would be similarly difficult, just as they are in trade. Opinions concerning intellectual property vary widely around the world, and because climate-friendly solutions will not all be homegrown, signatories will need to reach a consensus if any agreement is to succeed. In the absence of strong intellectual property rights, Harstad says, countries will be hesitant to devote money to research and development. Technological investments should be rewarded with contracts and licensing agreements that reward investors, he argues. If they are not, climate treaties would have to be more stringent to counteract weak intellectual property rights. Finally, protectionism is another barrier that could dampen investment worldwide. Countries seeking to protect their domestic efforts could impose high tariffs on imported technologies, reducing the innovator’s profit potential.
Though many details such as these need to be negotiated in a global climate treaty, some are typically left open ended. Investment levels are one example. “Just like the Kyoto Protocol, my model allows countries to negotiate how much they pollute, but not how much they invest,” Harstad says. Though an ideal climate agreement would specify research and development levels, such stipulations would be difficult to monitor and enforce, so existing agreements have not included investment mandates. This makes climate agreements incomplete contracts—not all details are specified.
Harstad used his model to determine how stringent an agreement’s other terms—pollution levels and duration—should be to spur adequate investment. In the case of short-term agreements, pollution levels should be almost draconian to have the desired effect. Longer-term agreements could offer more slack, but would still need to be strict enough to encourage sufficient research and development.
The best option, Harstad suggests, would be a long-term agreement with renegotiations. Rigorous pollution limits negotiated in the beginning would prod countries to invest heavily early on. Those that do not would find it costly to comply later on. And when renegotiations come around, laggard nations would have very little leverage against the countries that made the proper investments. Rather than suffer this fate, all nations will invest more up front, Harstad points out. Such an agreement would fix both the investment problem and the pollution problem, he says.
Tim De Chant was science writer and editor of Kellogg Insight between 2009 and 2012.
Harstad, Bard. 2010. The dynamics of climate agreements. Working paper, Kellogg School of Management.
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