Lecture 14

International Climate Agreements: Institutions, Incentives, and Strategic Cooperation

Byeong-Hak Choe

bchoe@geneseo.edu

SUNY Geneseo

November 14, 2025

🌐 From UNFCCC to Paris: The Global Climate Framework

Why Do We Need International Climate Agreements?

• Climate change is a market failure on a global scale.

• Because the benefits of climate action are shared globally, but the costs are borne locally, cooperation is essential.

• International climate agreements aim to:

  • Coordinate actions
    
  • Set shared goals
    
  • Build transparency and trust
    
  • Limit free-riding

Key Actors in Global Climate Governance

• UNFCCC (1992)
  • The United Nations Framework Convention on Climate Change.
    
  • It provides the overall framework for coordinating global climate action.
• COP — Conference of the Parties
  • The annual meeting of all UNFCCC member countries.
    
  • The main global forum where international climate decisions are made.
• At the COP, countries:
  • Negotiate climate agreements
    
  • Review progress; Update rules and commitments
    
  • Oversee implementation of the Paris Agreement (2015)

From UNFCCC to Paris: A Brief Timeline

1992 — UNFCCC Established
Countries agree climate change is a global problem requiring coordinated action.

1997 — Kyoto Protocol (COP3)
Binding emission targets for developed countries only.
Limited participation; U.S. never ratified; major emitters had no obligations.

2009–2014 — Negotiation Failures & Rising Urgency
2009 - Copenhagen (COP15) fails to deliver binding global targets.
Scientific evidence strengthens; pressure for a new model increases.

2015 — Paris Agreement (COP21)
Nearly all countries (195 countries) adopt a universal climate framework.

Today under the Paris Agreement
Focus on raising ambition, transparency, and implementation of Nationally Determined Contributions (NDCs)

How the Paris Agreement Differs from Kyoto

Kyoto Protocol

• Binding targets for developed countries only
  
• Targets were assigned to countries
  
• Weak enforcement → limited impact
  

Paris Agreement

• Universal participation: all countries submit plans
  
• Uses Nationally Determined Contributions (NDCs):
  • Each country sets their own targets
    
  • Targets must strengthen over time
• Ambition is high, but actions are voluntary

Transparency & Accountability in the Paris Agreement

• Every 5 years, Global Stocktake evaluates collective progress and informs the next round of NDCs.
• Transparency system tracks actions but has no formal penalties.

🌐 Global Climate Policy in a Fragmented World

The Free-Rider Problem

Climate mitigation is a global public good:

• Benefits are shared globally, regardless of who pays
  
• Costs of abatement are borne locally
  
• Benefits are non-rival (one country’s gain doesn’t reduce another’s)
  
• Benefits are non-excludable (no country can be excluded)

Implications

• Countries consider only their private MB, not the social MB
  
• They reduce emissions until MC = private MB
  
• Efficient global mitigation requires MC = social MB
  
• Since private MB < social MB:
  • Mitigation is under-provided; Global emissions remain too high

Why Cooperation Is So Hard

Climate change is one of the hardest collective action problems in human history.

• Global public goods → strong free-rider incentives
  
• Benefits of mitigation occur over long time horizons
  
• Uncertainty about future damages and benefits
  • Climate impacts vary by region and involve probabilistic risks.
    
  • Governments may discount or underweight uncertain future gains.
    
• Asymmetric climate risks, capacities, and responsibilities
  • Countries differ in vulnerability, development stage, historical emissions, and fiscal capacity.
    
  • These differences make it hard to agree on “fair” effort-sharing.
    
• No supra-national authority to enforce compliance

Key Features of Climate Agreements

Effective international agreements require the right incentive structure.

Incentive-Compatible

Each country has a self-interested reason to:

• Join the agreement
  
• Comply with the agreement’s rules once they join
  
• Avoid strategic behavior such as delaying action or shifting emissions abroad

Self-Enforcing

When incentives are aligned, the agreement becomes self-enforcing:

• Countries voluntarily join, stay, and comply without external enforcement
  
• The coalition remains stable over time
  
• Reward and penalty mechanisms discourage withdrawal

🌍 Why Global Climate Policy Is So Challenging

• Climate change is a global market failure, but climate policy is designed domestically.
  
• This disconnect generates major policy spillovers — the effects of a policy made in one country that spread to others — through international trade.
• Two fundamental tensions:
  • Competitiveness concerns
    
  • Free-riding concerns
• When climate policies vary across countries, these tensions intensify → need for:
  1. Carbon Border Adjustment Mechanisms (CBAMs)
  2. Climate Clubs
  3. Coordination of subsidies

🌐 Policy Variation Across Countries

	High Ambition	Low Ambition
Cost-Imposing	EU, Canada	Japan (low coverage)
Cost-Reducing	U.S. (post-IRA (Inflation Reduction Act))	Many developing countries

Countries differ along two key dimensions:

1. Ambition
   • High vs. Low mitigation effort
     
2. Policy approach
   • Cost-imposing (carbon taxes, cap-and-trade)
     
   • Cost-reducing (subsidies, tax credits, industrial policy)

• Countries experience spillovers from both ambition gaps and policy-design gaps.

⚙️ Why Spillovers Occur

• International trade exposes differences in ambition levels, carbon prices, and subsidy policies across countries.
• When one country raises carbon prices:
  • Domestic production costs rise
    
  • Imported goods become relatively cheaper
    → Competitiveness losses
• When climate ambition differs:
  → Free-riding becomes attractive
  
• When subsidies for clean technology differ across countries:
  → Firms move toward more generous support, causing:
  • Investment shifting: production relocates to high-subsidy regions.
  • Subsidy races: countries escalate subsidies to compete for green industries.

🎁 Subsidies as an Alternative to Carbon Pricing

Some countries choose subsidies instead of explicit carbon prices:

• Clean electricity tax credits
  
• EV and battery subsidies
  

• Hydrogen & CCUS incentives
  
• Industrial policy for green manufacturing

🇺🇸 U.S. Inflation Reduction Act (2022)

• Federal support: >$350B (official estimate), but because the credits are uncapped, total costs could reach $800B–$1T by 2032
• Emissions impact: Expected to cut U.S. emissions 32–42% below 2005 levels by 2030.
  
• Investment boost: Already triggered $240B+ in private clean-energy investment by 2024.
  
• Equity measures: Includes programs for low-income communities and methane reduction in oil and gas.

⚖️ Subsidies: Problems vs. Potential Benefits

⚠️ Problems with Subsidies

• Very expensive fiscally
  
• Can be regressive
  • (High-income households capture more tax credits)
    
• Can create international tensions, especially when they include:
  • Domestic content requirements
    
  • Targeted manufacturing subsidies
    
• Risk of subsidy races

🌞 When Subsidy Races Are Beneficial

• Not all subsidy races are wasteful
  
• Clean-energy innovation has positive externalities
  
• Faster deployment can reduce global technology costs
  
• Example:
  • China’s solar subsidies helped drive down worldwide solar PV prices
    

🏭 Carbon Pricing: Competitiveness Problems

• Carbon pricing raises costs for fossil fuels, electricity, and energy-intensive inputs.

• The most affected sectors are EITE (energy-intensive, trade-exposed) industries: Steel, Aluminum, Glass, Cement, Chemicals, Fertilizer

• Why These Sectors Are Vulnerable

  • Import competition from countries with weaker climate policy
    
  • Risk of offshoring (firms relocate to lower-cost jurisdictions)
    
  • Carbon leakage — emissions move abroad instead of falling globally

🔄 Carbon Leakage: What the Evidence Shows

• Leakage is theoretically plausible but empirically mixed.
• Most emissions come from non-traded sectors, so leakage is limited overall.
• BUT leakage risks are concentrated in EITE sectors.
• Policymakers fear:
  • Job losses
    
  • Domestic industry decline
    
  • Perception of “unilateral sacrifice”

🚧 Carbon Border Adjustment Mechanisms

A tariff on imports designed to equalize carbon costs between domestic and foreign producers. It is calculated based on:

1. The carbon content of the imported good
   
2. The gap between domestic and foreign carbon prices
   

• If the EU carbon price is $110/ton and China’s price is $10/ton, then:
  \[ \text{Tariff} = (\$110 − \$10) × \text{carbon content} = \$100 \text{ per ton CO₂} \]

Outcome of CBAM

• Imported and domestic goods face the same effective carbon cost
  
• Reduces competitiveness concerns and carbon leakage

🇪🇺 EU CBAM (2023– )

• Covers EITE sectors and electricity.
  
• Gradual phase-in while free ETS allowances are phased out
  
• Designed for WTO compatibility

🧮 Measurement Challenges with CBAMs

A CBAM must estimate the carbon content of imports, which is technically difficult.

• Sector-average benchmarks
  • Simple to use, but may overcharge clean plants and undercharge dirty ones.
• Big plant-level variation
  • Emissions differ widely across facilities depending on technology, fuel, and electricity mix.
• Uneven or unreliable reporting
  
• Risk of “reshuffling”
  • Clean products sent to CBAM markets; dirtier products sold elsewhere
    → Changes trade patterns but not global emissions.

🧪 What Recent Research Finds about CBAMs

Using plant-level data on steel and aluminum (the first EU/UK CBAM sectors):

• Competitiveness improves
  • Domestic producers no longer face a disadvantage vs. low-regulation countries.
• Leakage declines
  • Importers effectively face the same carbon price.
• Positive regulatory spillovers
  • Foreign firms gain incentives to clean up or price carbon.
• Limited harm to low-income countries
  • They export little in these sectors; cleaner producers gain share; revenue impacts are small.

Takeaway: CBAMs can boost competitiveness, reduce leakage, and encourage regulation without major equity harms.

📉 Why CBAMs Have Limited Global Impact

CBAMs are only a partial climate tool.

• Apply to a small set of EITE sectors only.
  
• Do not address most domestic emissions sources.
  
• Some reshuffling remains.
  
• Countries not exporting to the EU have weak incentives to change policies.

Overall

• CBAMs strengthen competitiveness, reduce leakage, and raise foreign ambition
• But global emissions fall only modestly unless more sectors and countries participate.

🌍 Climate Clubs: A Simple Idea with Big Potential

• Goal: Reduce global free-riding by rewarding members and penalizing non-members.
  
• Concept (Nordhaus, 2015):
  • A coalition of high-ambition countries forms a club.
  • Members agree to strong climate policies (e.g., carbon pricing, standards).
  • Non-members face a uniform external tariff on all exports to the club.

🌍 Climate Clubs

How Climate Clubs Differ from CBAMs

• CBAM → Sector-specific, focused on competitiveness & leakage.
  
• Climate Club → Economy-wide, focused on raising global ambition.

Why No “Real” Climate Club Exists Yet

• Countries use different policy tools (carbon pricing vs. subsidies).
  
• Broad tariffs risk WTO disputes and trade conflict.
  
• Political difficulty defining a single metric of “high ambition.”

👉 Today: only “soft clubs” exist (G7 Climate Club). No binding, enforcement-based club has formed.

🌏 Equity & Development Considerations

• Low-Income Countries account for only ~4% of global emissions
• Low- and Middle-Income Countries for ~25%—yet they are the most vulnerable to climate damages.
• Many rely on energy-intensive exports and have limited capacity to meet complex reporting requirements.
• To ensure fairness:
  • CBAM or climate-club tariffs should exempt the poorest countries or include transition periods.
    
  • Rich countries must provide financial assistance, technology transfer, and capacity-building for emissions reporting.
    
  • Global policy design should avoid shifting costs onto countries least responsible for the problem.

🔮 Broader Implications for Trade & Climate

• About 25% of global CO₂ emissions are embodied in traded goods, meaning trade policy directly shapes global mitigation.
• WTO rules often favor high-carbon production, because:
  • Carbon tariffs are difficult under WTO rules because they can appear discriminatory or protectionist.
  • Fossil-fuel subsidies remain largely unconstrained.
    
• Better-coordinated border measures could:
  • Reduce implicit fossil-fuel subsidies embedded in international trade.
  • Strengthen incentives for cleaner production in exporting countries.
  • Limit trade disputes by creating common reporting and verification standards.

🧭 The Future Depends on Four Actors

Global decarbonization will hinge on the policy choices of four major emitters:

• United States — subsidies-driven clean-tech expansion (IRA).
  
• European Union — carbon pricing + CBAM architecture.
  
• China — dominant in clean-tech manufacturing; key coal and industrial emissions.
  
• India — fast-growing economy; crucial for long-term global emissions trends.

Their interaction on carbon pricing, subsidy policy, border adjustments, and climate-club cooperation will shape whether the world moves toward coordinated climate action or fragmented policy competition.

🌍♟️ Game Theory of Global Climate Cooperation

Collective Action and Game Theory

• Climate mitigation is a classic case of strategic interdependence:
  • The benefits of reduced emissions are global and shared by all.
  • The costs of abatement are local and borne individually.
    
    → Each country’s payoff depends on what other countries decide to do.
• Because countries affect one another’s outcomes, incentive design becomes central to climate cooperation:
  • Agreements must be incentive-compatible (acting responsibly is each country’s best response).
  • Agreements must be self-enforcing (no country wants to cheat or exit).
• This is exactly what game theory studies: how each player’s payoff depends on their own actions and the actions of others.

A Climate Game: Cooperation vs. Defection

		Country B
		Cooperate	Defect
Country A	Cooperate	(3, 3)	(1, 4)
	Defect	(4, 1)	(2, 2)

• Players
  • Two countries: Country A and Country B.
• Strategies
  • Cooperate → adopt strong climate policy / abate emissions
    
  • Defect → keep weak or no climate policy / avoid abatement costs
• Payoffs
  • Higher values = better economic outcome
  • Format: (A’s payoff, B’s payoff)

Nash Equilibrium in the Climate Game

		Country B
		Cooperate	Defect
Country A	Cooperate	(3, 3)	(1, 4)
	Defect	(4, 1)	(2, 2)

• In a Nash Equilibrium (NE), each player’s chosen strategy is the best response to the other player’s strategy.
  • A NE occurs when no player can improve their payoff by changing strategy unilaterally.
• What is the NE in this game?
  • That is, to find what strategy each player plays in the NE.

Nash Equilibrium in the Climate Game

		Country B
		Cooperate	Defect
Country A	Cooperate	(3, 3)	(1, 4)
	Defect	(4, 1)	(2, 2)

• If B cooperates → A prefers Defect (\(4 > 3\))
  
• If B defects → A prefers Defect (\(2 > 1\))
  
• If A cooperates → B prefers Defect (\(4 > 3\))
  
• If A defects → B prefers Defect (\(2 > 1\))

👉 NE = (Defect, Defect) — even though both prefer \((3,3)\).

• This is the classic Prisoner’s Dilemma.
  Free-riding incentives push both countries toward mutual defection.

The Climate Game with CBAMs

		Country B
		Cooperate	Defect
Country A	Cooperate	(3, 3)	(2, 1)
	Defect	(1, 2)	(1, 1)

• What the strategies mean under CBAM:
  • Cooperate → adopt a strong domestic climate policy (abate emissions).
    
  • Defect → keep a weak policy (under-price carbon) and face CBAM tariffs on exports.
    • The tariff removes the competitiveness advantage of weak policy.

👉 CBAMs internalize the competitiveness problem, eliminating the gain from under-pricing and making Cooperate → a dominant strategy.

The Climate Game with Climate Clubs

		Country B
		Cooperate	Defect
Country A	Cooperate	(4, 4)	(2, 1)
	Defect	(1, 2)	(1, 1)

• What the strategies mean under Climate Clubs:
  • Cooperate → join the club (adopt high-ambition policy; gain tariff-free access, shared standards, and technology cooperation).
    
  • Defect → stay out (keep weaker policy; face club-wide external tariffs).
    • Staying out results in tariff penalties and loss of club benefits.

👉 Climate Clubs flip the incentives: joining the club yields the highest payoff, making high-ambition climate policy a dominant strategy.

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