Lecture 23

Climate Change I: The Nature of the Challenge

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

October 30, 2024

The Economics of International Climate Agreements

Game Theory Perspective

  • Why is Game Theory Relevant to Climate Change?
    • Game Theory is the study of strategic interactions among rational decision-makers.
    • Countries face incentives to either cooperate (reduce emissions) or defect (not reduce emissions).
    • Climate change is a global issue requiring collective action.

The Economics of International Climate Agreements

  • Self-Enforcing Agreements:
    • Designed to provide incentives for countries to join and comply without external enforcement.
  • Free-Rider Effect:
    • Nations benefit from others’ emission reductions without contributing themselves, undermining collective efforts.
    • This makes it difficult to construct self-enforcing agreements.

The Economics of International Climate Agreements

A Simple Game Theory

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: Invest in reducing GHG emissions.
    • Defect: Continue emitting at current levels to avoid immediate costs.
  • Payoffs are in the format (Country A’s payoff, Country B’s payoff)

The Economics of International Climate Agreements

A Simple Game Theory

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.
    • In a NE, no player can unilaterally change their strategy to achieve a better payoff.
  • What is the NE in this game?
    • That is, to find what strategy each player plays in the NE.

The Economics of International Climate Agreements

Barrett Model (1994)

Country B
Cooperate Defect
Country A Cooperate (5, 5) (3, 4)
Defect (4, 3) (2, 2)
  • In this version of the payoff matrix,
    • Reduced Incentive to Defect: The payoff for unilateral defection (4) is only slightly lower than mutual cooperation (5).
      • Smaller Penalty for Cooperating Alone: A country that cooperates while the other defects still receives a moderate payoff (3).
  • What is the NE in this game?

The Economics of International Climate Agreements

Barrett Model (1994)

Unstable Agreement Scenario

  • Challenges in Forming Agreements:
    • High incentives to defect lead to unstable agreements, as countries prefer short-term individual gains over long-term collective benefits.
  • When the potential gains from unilateral defection are large, the likelihood of sustaining cooperative agreements diminishes.

Stable Agreement Scenario

  • Facilitating Cooperation:
    • Adjusting payoffs to reduce the attractiveness of defection encourages countries to cooperate.
  • Stable agreements are more likely when the incentives to defect are minimized, and the benefits of cooperation are sufficiently attractive.

The Economics of International Climate Agreements

Barrett Model (2013)

  • Coordination with Certainty:
    • When the catastrophic climate threshold is clear and benefits outweigh costs, countries can effectively align their actions.
    • Self-enforcing treaties help prevent the catastrophe.
  • Breakdown with Uncertainty:
    • Uncertainty about the temperature rise triggering catastrophe weakens coordination.
    • Lack of clear thresholds causes hesitation, leading agreements to fail.

The Economics of International Climate Agreements

Strategies to Enhance Cooperation

  • Issue Linkage:
    • Definition: Combining climate agreements with other economic treaties (e.g., trade, R&D) to create mutual benefits.
    • Example: Linking climate action with technological cooperation or trade liberalization.
  • Climate Clubs:
    • International Carbon Price: A uniform carbon pricing mechanism among club members.
    • Tariffs on Non-Members: Imposing tariffs on imports from countries not adhering to the club’s carbon pricing.
    • Example: EU’s proposed Carbon Border Adjustment Mechanism (CBAM), aimed at incentivizing non-EU countries to adopt similar carbon pricing.

The Economics of International Climate Agreements

Funding Transfers: Adaptation Fund (2001)

  • Adaptation Fund:
    • Establishment: Created to finance specific adaptation projects and programs in developing countries that are parties to the Kyoto Protocol.
    • Purpose: Supports projects aimed at enhancing resilience and reducing vulnerability to climate impacts.
    • Incentive for Participation:
      • Access to the fund is exclusively available to parties in the agreement.
      • Encourages potential holdouts to join the Kyoto Protocol by offering financial support.

The Economics of International Climate Agreements

Funding Transfers: Green Climate Fund (2010)

  • Establishment:
    • Initiated by the Conference of Parties (COP) to the United Nations Framework Convention on Climate Change (UNFCCC).
  • Purpose:
    • Provides significant funding to developing countries to:
      • Mitigation: Limit or reduce their greenhouse gas emissions.
      • Adaptation: Adapt to the impacts of climate change.
  • Impact:
    • As of August 2024: 286 proposals approved, facilitating widespread support ($16 billion) for climate action in 133 developing countries

The Precedent: Reducing Ozone-Depleting Gases

Montreal Protocol (1988)

  • Objective:
    • Phase out the production and use of ozone-depleting substances (ODS), such as chlorofluorocarbons (CFCs).
  • Success Metrics:
    • Participation: 197 countries are signatories.
    • Effectiveness: 99% phase-out of targeted ODS.
    • Outcome: Ozone layer recovery expected by 2075.

The Precedent: Reducing Ozone-Depleting Gases

Key Factors for Success

  • Multilateral Fund:
    • Established in 1990 to support developing countries in phasing out ODS.
    • Financed by industrialized countries to cover incremental costs and facilitate technology transfer.
  • Availability of Substitutes:
    • Development and commercialization of alternative technologies reduced economic burdens.
    • Producers transitioned to substitutes without significant losses, accelerating compliance.

The Precedent: Reducing Ozone-Depleting Gases

Lessons for Climate Policy

  • Inclusive Participation:
    • Engaging both developed and developing countries ensures widespread compliance and effectiveness.
  • Economic Incentives:
    • Financial support mechanisms and technological alternatives lower the cost of compliance, encouraging participation.

Climate Change I: The Nature of the Challenge

Summary

  • Need for Action: Both scientific and economic analyses confirm urgency

  • Barriers: Free-rider effects, political complexities

  • Optimistic Pathways:

    • Issue linkage, co-benefits, climate clubs
    • Lessons from the Montreal Protocol

  • Challenges Remain: Energy use control, political will

  • Conclusion: Knowledge is sufficient (Climate Change 2023 Synthesis Report - Summary for Policymakers, IPCC (2023)); political action is required to implement necessary policies