International trade and the feasibility of global climate change agreements

Raymond Riezman, John Whalley, Yuezhou Cai, 9 April 2009

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How strong are the incentives for countries either individually or collectively to reduce carbon emissions? While countries’ actions may be guided by collective interests as much as individual interests, the role of self-interest deserves careful examination. Negotiations aimed at reducing global temperature proceed by having countries mutually agree to reduce carbon emissions, jointly internalising the associated global externalities from emissions. In practice, what form actual negotiations take will depend on agreements struck between participants, including penalties on non-participants. We limit our discussion to the participation decision and do not discuss the form that cooperative arrangements will take. We emphasise the potential contribution of international trade in facilitating individual country participation in negotiations.

Climate change is a classic global externality problem that has been analysed either explicitly or implicitly by Shapley and Shubik (1969), Barrett (1994), Uzawa (1999) and others. Their research shows that unless there are side payments, small countries have little incentive to participate in cooperative arrangements that either fully or partially internalise the externality. This is because small countries bear the costs of their carbon mitigation actions, while their benefits from resulting improvements in global climate are small, since they are small. Large countries will have greater incentive to participate, as their actions, while costly to them, can have a significant positive impact on their own welfare via temperature change.

Simulation results

We have used numerical simulations to investigate these issues. We use a business-as-usual global scenario for our simulations considering periods of thirty years (to 2036) and fifty years (to 2056.) We assess counterfactual outcomes using a general equilibrium model featuring international trade and preferences over climate change impacts. In particular, we are interested in whether country size, the coalitional activity by countries, the length of the time horizon, threat assessment, and the presence of international trade affect a country’s willingness to participate in carbon reduction activities.

We begin by discussing the role of country size. To reduce carbon emissions, a country reduces its own production. This results in two offsetting effects. The direct effect of reducing production is that consumption declines and welfare declines. However, reducing carbon emissions also lowers global temperatures for all countries and that increases welfare for everyone. If a country is large, the output reduction is more likely to have a significant effect on global temperatures. On the other hand, a small country that reduces output suffers the direct welfare loss from reduced consumption but has relatively little effect on global temperatures. Hence, we find that large countries are more likely to unilaterally limit carbon emissions and are more likely to be interested in pursuing carbon reduction agreements.

Forming coalitions of countries to reduce carbon emissions strengthens these incentives. As members of a coalition, countries that agree to reduce carbon emissions see a bigger reduction in global temperatures for a given reduction of output for each individual country. Of course, forming the “grand coalition” of all countries in the world is the best way to proceed, but if that is not possible then forming smaller coalitions for carbon reduction agreements is a strategy that would be effective in limiting carbon emissions. Our results suggest, however, that only if global damage is anticipated to be very large (greater than 20% of GDP) will self-interest prompt countries to engage in unilateral carbon emission reduction activity.

We also find that the longer a country’s time horizon, the more willing it is to reduce carbon emissions. For example, if a country’s time horizon is 30 years, the business-as-usual scenario in the Stern Report (2006) predicts average global temperatures will increase about 2°C whereas if the time horizon is fifty years the prediction is that the temperature rise will be 5°C. The potential benefit of a given output reduction now is much larger if the time horizon is fifty years than if it is thirty years.

Countries also differ in their environmental preferences. Not surprisingly, our research shows that countries that care more about global temperatures will be willing to do more to reduce carbon emissions now. Hence, from a political point of view, to the extent that political forces within countries that have strong feelings about climate change can make their voices heard, countries are more likely to adopt policies that will reduce carbon emissions.

Finally, we consider the role that international trade plays in leading to agreements to reduce carbon emissions. International trade can facilitate carbon reduction in three different ways. First, when a country reduces the output of a good it exports then if the country is large, its terms of trade will improve. We document how this could lead to an increased willingness to unilaterally reduce carbon emissions. Second, to the extent that countries already have frameworks in place to discuss international trade issues, those same forums can be used to facilitate agreements to mutually reduce carbon emissions. Finally, international trade allows countries that produce specific goods using very carbon-intensive methods to import the same goods from a country using less carbon-intensive production technologies.

Conclusions

We have looked at the incentives for countries to reduce carbon emissions with an eye towards reducing global temperatures. While our results emphasise that damage from global temperature increases needs to be large before countries will reduce carbon emissions unilaterally, we have isolated several key factors that will contribute to the willingness to reduce emissions. Larger countries should be more willing to participate. International agreements to jointly reduce carbon emissions should be encouraged. Countries adopting a longer-term view and those who take the threat more seriously will be more inclined to reduce carbon emissions. Finally, we argue that international trade is largely a positive force in reducing carbon emissions.

Authors' Note: We are grateful to the Center for International Governance Innovation (Waterloo) for financial support.

References

Barrett, Scott, 1994, Self-Enforcing International Environmental Agreements, Oxford Economic Papers, Vol. 46, Special Issue on Environmental Economics, pp.878894.

Shapley, Lloyd, and Shubik, Martin, 1969, On the Core of an Economic System with Externalities, The American Economic Review, Vol.59, No.4, pp678-684.

Stern, Nicholas, 2006, Stern Review on the Economics of Climate Change, London, UK: Her Majesty’s Treasury.

Uzawa, H, 1999, Global Warming as a Cooperative Game, Environmental Economics and Policy Studies, 1999, Vol.2, pp.1-37.

Topics: Environment, Global governance, International trade
Tags: carbon emissions, climate change

Chinese Academy of Social Sciences (CASS) - Institute of Quantitative & Technical Economics
Henry B. Tippie Research Professor of Economics at the University of Iowa
Professor and William G. Davis Chair in International Trade, Department of Economics, University of Western Ontario