Pegram Lecture 2, August 10, 2012

Economic Returns from
the Biosphere
Pegram Lecture No 2
Brookhaven National Laboratories, LI
New York
Graciela Chichilnisky
www.chichilnisky.com
Columbia University

Columbia Consortium for Risk 1
Management (CCRM)
www.columbiariskmanagement.net

Human beings, or their close genetic relatives,
have lived on Earth for several million years

Yet only recently has human activity reached
levels at which it can affect fundamental natural
processes
 the concentration of gases in the
atmosphere (CO2, Ozone)
 the planet’s water mass
 The complex web of species which
constitute life on earth

Management (CCRM)

Changes in global atmospheric composition
Atmospheric Concentration of CO2 ,
1959-2000 Sources:
Carbon Dioxide Mixing Ratio (ppm)

380
370
360

Fossil Fuel Consumption
350
340
330
320
310
300
Forest Burning
290
280
1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999

Atmospheric Concentration of CFC-12,
1978-2001 The Facts - Trace
600
Refrigerants Gas
CFC-12 Mixing Ratio (ppm)

500

400
Foam Blowing Concentrations
300

are increasing
Solvents
200

100

0
1978 1982 1986 1990 1994 1998

Atmospheric Concentration of
Methane, 1986-2001

Rice Paddies
1,740
Methane Mixing Ratio (ppm)

1,720

1,700

1,680

1,660

1,640
Marshlands
1,620

1,600

1,580
Cattle
1,560
1986 1990 1994 1998

Source: World Resources Columbia Consortium for Risk 3
Institute, 2002 Management (CCRM)

Management (CCRM)

Source: National Oceanic and Atmospheric Administration (NOAA). US Department of
Commerce. http://www.noaa.gov/

Management (CCRM)

Policy responses to
Atmospheric Changes
 1988: Intergovernmental Panel on
Climate Change is created
 Ultimate global authority on climate
change issues – US is part of it
 1992: Rio UN Earth Summit targets -
roll back industrial countries emission
to 1990 levels by 2000
 A long road since Rio
Management (CCRM)

Sources: “A timeline of climate change” Matthew Knight, CNN science, 14, May 2008.
http://www.cnn.com/2008/TECH/science/03/31/Intro.timeline/index.html (the rest came from G. Chichilnisky directly).

Management (CCRM)

How to achieve the Rio targets?
Proposals:
 Global carbon taxes (OECD Study,
1993 – 4
 Global markets for carbon emission
permits (Chichilnisky’s proposals: 1
1. proposal to OECD, 1993, 2. 1996
& 1997 proposal to UN Framework
Convention on Climate Change, Chair
R. Estrada-Oyuela, and 3. proposal
to World Bank 1995)
Management (CCRM)

1995 Berlin Mandate

 Negotiate Protocol to quantify
limitations by industrial countries,
e.g. in 2000, 2010, 2020
 Joint implementations pilot
 Prelude to emissions trading

Management (CCRM)

Geneva: June 1996

 U.S. Undersecretary of State Tim
Wirth proposes my initiative on
global emission markets

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1996

● In 1996, the IPCC reported that
human induced emissions of carbon
have a discernible effect on climate

● Scientific uncertainty persists

● But it is recognized that the risk of
climate change is real and potentially
catastrophic

Management (CCRM)

Kyoto: 1997

 166 nations accepted our
emissions market proposal to
UNFCCC

The Kyoto Protocol
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The Kyoto Protocol
 1997: Kyoto Protocol was signed

 Including the Carbon Market – which
I wrote into the Kyoto Protocol draft

 But emissions continue to increase
outside the KP nations

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1998 BUENOS AIRES COP4

Set 2 year deadline for completing
the KYOTO AGENDA

Management (CCRM)

The Carbon Market

Kyoto set 5% emission reductions
for Annex 1 countries by 2008-2012
and created three facilitating
mechanisms to achieve this

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KP: Facilitating mechanisms for
Annex 1 countries

 Joint implementation (article 6)
 Emission trading (article 17)

See also art 3.10 and 3.11
 Clean Development Mechanism

(CDM)

Management (CCRM)

•
The Carbon Market
Kyoto is the first international
agreement based on a market
mechanism
The Kyoto Protocol sets caps on CO2
emissions, and allows industrial
nations to trade the rights to emit*

* My proposal for a carbon market, written into the KP

Management (CCRM)

Only one mechanism involves both
industrial and developing countries:

CLEAN DEVELOPMENT
MECHANISM
(ARTICLE 12)

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2005: Kyoto Protocol becomes
international law

The Kyoto Protocol sets caps on
CO2 emissions, and allows industrial
nations to trade the rights to emit

The Carbon Market becomes
international law in 2005
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Kyoto becomes international law

 2005 Kyoto Protocol and its carbon
market become International Law
 2009 Copenhagen COP 15, I
introduce the Green Power Fund and
Negative Carbon into the CDM
 2011 KP Carbon Market trades $200
Bn/year*
 *The World Bank: “Facts and Trends of the Carbon Market” WB Annual Publication,
2011

Management (CCRM)

Global emissions
 Since 2005 Kyoto Protocol led to
about 30% reduction in EU
emissions.
 Cf. The World Bank: Facts and Trends of the Carbon Market, 2011

 But emissions continue to increase
outside the Kyoto Protocol nations

Management (CCRM)

Source: National Oceanic and Atmospheric Administration (NOAA). US Department of
Commerce. http://www.noaa.gov/

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2007 BALI - COP 13:

The Bali Roadmap

2009 COPENHAGEN COP15

Reducing the U.S. – China impasse

A NEW COLD WAR?
Management (CCRM)

Copenhagen 2009
 COP 15 - I introduced
1. The Green Power Fund - accepted and
announced by Sec of State H. Clinton two
days later in Copenhagen

2. Carbon Negative Technologies into the CDM

Two seeds with Irresistible Growth*
*Chichilnisky, G. 2012 The National Journal “Two Seeds of Irresistible Growth”

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2011: Durban COP 17
 The Green Power Fund is partly
accepted as the Green Climate Fund

 Carbon Negative Technologies
become part of the CDM

What is missing?

Management (CCRM)

The Carbon Market
 Is now mandatory in 4 continents:
EU, Asia, Australia and the Americas
- in Quebec Canada and in California
USA
 Trading $200 Bn/year in EU ETS
 CDM has transferred over $50Bn for
clean tech projects in developing
nations
The World Bank: “Facts and Trends of the Carbon Market” annual
report 2005 - 2011 26
Columbia Consortium for Risk
Management (CCRM)

Policy responses
The Carbon Market Works

The EU ETS Carbon market reduced
about 30% of EU and Japan’s
emissions since 2005
The World Bank ‘Facts and Trends of the Carbon Market’ 2011

Management (CCRM)

2011: “Increased Ambition”
 December 2011: Durban South
Africa COP 17 extends Kyoto Protocol
mandatory carbon limits until 2015

 COP17 votes to provide a mandate to
establish global limits by 2020

Durban Platform for Enhanced Action
Management (CCRM)

Three outstanding issues for
implementation of the Kyoto
Protocol
 Opposition from the private sector

 Developing countries do not participate in
emissions limits

 U.S.-China impasse: A new Cold War?

Management (CCRM)

All three issues arise from
fears that emissions limits will
interfere with economic growth
and the rise in standards of
living

Critical for all nations
especially for developing
countries
Management (CCRM)

How to cut the link between
emissions and economic
growth?

Only new clean technologies can
achieve this
The carbon market is the solution
It introduces a price for carbon and
makes clean technology profitable, and
fossil fuels expensive and undesirable
Management (CCRM)

How the Carbon Market and its Green
Power Fund Overcomes these Issues
 Green Power Fund – a $200 Bn/year
private public fund
 Funded by Carbon Market – which already

trades $200 Bn/year
 Funding to provide off takes to build

carbon negative power plants in LA, Africa
and AOSIS
This is the ONLY WAY the CDM can bring
funding to these three regions – why?

Management (CCRM)

The Carbon Market
Changes the Global Economy

New technology requires
appropriate economic
conditions to be
implemented.

Resource prices are key
Management (CCRM)

Prices have an impact
A much-quoted statistic on this subject is
that the amount of energy used in
producing $1000-worth of constant-dollar
GNP in the USA fell by 38.9% from 1973
to 1983.

This was a result of switching to more
energy-efficient technologies, and mostly
of demand patterns changing away from
energy intensive products and services.
Most of this striking drop in energy use
occurred in the period 1979-1983.
Management (CCRM)

New Technologies
(fuel cells, solar)
seem uncompetitive because of
excessively low resource prices
and a $400 Bn/year subsidies to
the coal industry

In real terms, oil prices are still
relatively low
Management (CCRM)

Through clean technologies,
developing countries can
“leapfrog”, without repeating the
resource-intensive growth that
characterizes industrial
countries

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Technology transfers and
emissions trading

Today there is no incentive for a USA
corporation to set plants in
developing countries using modern,
clean technology

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Carbon MARKETS

Change all this
They reward the transfers of clean
technology

How?

Management (CCRM)

Before the Carbon Market

The profits obtained by a firm are the
same for a Ford factory that
produces car parts in China using
dirty technology or clean
technology

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After the Carbon Market

If Ford is allocated carbon
credits for clean car technology
corresponding to the emissions
saved, it can cash these permits
in the emissions market

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Carbon Market
for Emission Credits

In the KP Annex 1 Countries were
given allocations of property
rights on emissions summing up
to a 5% reduction from 1995
global emissions, and they can
trade these freely among
themselves
Management (CCRM)

REDD
 A proposal to provide carbon credits for
“Reducing Emissions from Deforestation and
forest Degradation”

 Not accepted by UNFCC because of low
effectiveness. Recent IPCC Canadian study
showed that forests are too slow as sinks of CO2:
If every square ft of arable land in the planet was
planted, it would not absorb more than 10% of
CO2 that humans emit by the end of the 21st
century.

Management (CCRM)

Yasuni Initiative*
 President Correa of Ecuador requests compensation from
the international community for not cutting down their part
of the Amazon forest to explore and extract petroleum

 60% of Ecuador’s population is indigenous and has opposed
for many years the use of Ecuador’s forests by international
oil companies

 60% of Ecuador’s export revenues are from petroleum

 *The Economics of the Yasuni Initiative, Joseph Henry Vogel,
Initiative
foreword by G. Chichilnisky, Anthem Press, 2009

Management (CCRM)

OTHER EXAMPLES
of Environmental Markets*

 The trading of SO2 in the Chicago
Board of Trade since 1993, following
the Clean Air Act – successfully and
effficiently eradicated acid rain in the
US in 20 years
 Water Markets in Australia and
California
*Environmental Markets: Equity and Efficiency, Chichilnisky and Heal 2000

Management (CCRM)

Biodiversity and Markets for
emissions permits

Deforestation is the source of
approximately 20% of global
greenhouse gas emissions. Science
has shown that forests act as “sinks”
retaining large amounts of carbon
and absorbing large quantities of
carbon dioxide

Management (CCRM)

The watershed problem is global

 The value of watershed services to
major cities across the world is
estimated at $900 billion*

 One can securitize watershed
services through innovative financial
instruments
 * cf. G. Chichilnisky and G. Heal Nature 1995
Management (CCRM)

SECURITIZATION
 Form corporation to manage
conservation
 Corporation owns the cost savings
from conserving watershed
 Finance conservation by selling
shares
 Local community and state should
own shares
Management (CCRM)

Increased knowledge can help
How?
It can lead to:

 Better understanding of natural risks and
how to manage them
(El Nino and Catastrophe Bundles)
 Better understanding of human impacts on
nature and of new courses of action
(watersheds and environmental
bonds)
Management (CCRM)

Markets are widely used
institutions
They are decentralized, and can be efficient.
But global environmental markets trade
unusual goods: privately produced public
goods

● Biodiversity is one
● The planet’s atmosphere is another
Management (CCRM)

Environmental assets are often
public goods
 CO2 concentration in the atmosphere
is a quintessential public good
because it mixes very thoroughly
throughout the planet and is very
stable (remains about 100 years)
 It is not a typical public good
because it is not produced by the
government such as defense
 CO2 is privately produced
Management (CCRM)

Public goods change
matters
New Economic Findings
 Only certain allocations of property
rights on the atmosphere between
countries will yield efficient market
solutions
 This ties together the goals of
efficiency and fairness:
 The aspirations of North and South
Management (CCRM)

Privately produced public goods

 are goods which are not “rival” in
consumption, but are privately
produced

 we all produce emissions but the
atmosphere is the same for us all

Management (CCRM)

First Theorem of Welfare Economics

The allocation resulting from a competitive
market equilibrium with private goods is
Pareto efficient (Arrow, 1950)

 This theorem is independent of the
distribution of property rights. For
example: all but two traders may have
zero endowments of property rights and
the resulting equilibrium is still Pareto
efficient.
Management (CCRM)

• But it requires all traded
goods to be private goods,
with rival consumption, and
privately owned.

Management (CCRM)

Markets with PPP goods are
different from standard markets

In private goods markets,
efficiency and fairness are
separate concepts (often called
Coase’s theorem)

In markets with privately
produced public (PPP) goods these
two concepts are linked
Management (CCRM)

With private goods efficiency requires
that MRS=MRT, but with public goods
the formula changes:

Lindahl-Bowen and Samuelson proved
that:

Sum of MRS across people = MRT

Management (CCRM)

● For efficient markets, traders
should choose freely between
private goods and
environmental quality

● However the atmosphere
concentration of CO2 is one and
the same for all. This is an
unavoidable physical fact
Management (CCRM)

● Therefore free choice must
lead every trader to select the
same overall trade-off between
private goods and atmospheric
quality

● For this to happen, trader’s
wealth should not be too far
apart
Management (CCRM)

● Efficiency and distribution are
connected in markets with PPP
goods

● A measure of equity is necessary
for efficiency

● Markets with knowledge and
environmental assets require
equity for efficiency
Management (CCRM)

First Welfare Theorem in
Markets with Privately
Produced Public Goods
 Only a finite number of ways of
distributing property rights on a
given total of emissions rights
between the traders gives rise to
efficient market allocations*
 *Chichilnisky, Heal and Starrett 2000
Management (CCRM)

● Efficiency and distribution are
closely connected in economies
with environmental assets

● A measure of equity is
necessary for efficiency

Management (CCRM)

POLICY

Those who have fewer endowments
of private goods must be endowed
with more property rights on the use
of the PPP good. Otherwise the
market does not operate efficiently

Management (CCRM)

● One way to ensure this is to follow a
simple rule: the countries that emit less
receive somewhat more permits:

● A “reverse grand-fathering” allocation

● Repeated across time, such a policy
would compensate those who use the
atmosphere judiciously and provide
incentives to abate

Management (CCRM)

This scheme:
 Rewards the transfers of clean
technology to developing countries

 Multiplies the returns on R&D in the
private sector

 Securitizing these returns attracts
global capital from private sources
for clean technology transfers
Management (CCRM)

NEW MARKETS
A market has N traded goods and H
traders

Each trader has a preference uh : RN R

and an allocation of property rights

Ωh Є RN.

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What is economic efficiency:

A feasible allocation is Pareto
efficient if there is no other feasible
allocation which makes everybody as
well off, and some strictly better off

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A competitive equilibrium is a price p* ∈
RN and an allocation x1,…,xH ∈ RN x H such that
each trader maximizes utility subject to a
budget constraint:

Max uh(y) where y ∈ {z Є RN : <p*, z> = <p*,Ωh>}

And markets clear:
H H
Σ
h=1 xh Σ
= h=1Ωh.

Management (CCRM)

A competitive market equilibrium

Is a set of prices p* and an allocation of
goods x1,…, xH ∈ RN x H at which each trader
maximizes utility subject to a budget
constraint, and all markets clear.

Management (CCRM)

A General Model
•Consider a world economy with I countries, I ≥ 2 ,
indexed by i = 1,…,I. Each has a utility function ui ,
arguments a vector of private goods ci = (ci,1,ci,2,…,ci,m)
where m is the number of private goods, and also the
quality of the world’s atmosphere, a, which is a public
good.

• The quality of the atmosphere, a, is measured by
the reciprocal or the negative of CO2 concentration.
The concentration of CO2 is “produced” by emissions
of carbon, which are positively associated with the
production of private goods.
Management (CCRM)

•Let y be a vector giving the production levels of
the m private goods in the country i
I ∂φι
a = Σ ai , ai = Φ (yi) and < 0 ∀ i.
i=1 ∂yi,l
a is a measure of atmospheric quality overall, and
ai is an index of the abatement carried out by
country i.

•Feasibility is defined by the above and by the
condition that the total consumption of each
private good worldwide equal total production:

∑ c = i=1,…,I
i
i=1,…,I
∑ yi

This allows unrestricted lump sum redistributions.
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 A Pareto efficient allocation is the solution to the
problem of maximizing the utility of a designed
country, subject to the other countries all reaching
prescribed utility levels. This gives the following
conditions:

∂ui ∂uk
= λk ∂ci,l
∀ l = 1,…,m and ∀ k ≠ i.
∂ci,l

This implies common MRS for all countries. Country i
is the country whose utility is being maximized, and λk
is a Lagrange multiplier associated with the constraint
that country k reach a specified welfare level, and
∂uk
∂Φi ∂ci,l
∂yi,l = ∀l,
Σk λk ∂uk
∂a
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First Welfare Theorem for Markets with
Privately Produced Public Goods
Theorem

In an economy with k≥2 traders, j≥1private
goods and a public good, there exists at most a
one-dimensional manifold o property rights
allocations on the use of the public good
(allocation of “permits”) from which the
competitive equilibrium is Pareto efficient.

This is the Manifold of Efficient Allocations of
Property Rights
Management (CCRM)

First Welfare Theorem

In Markets with Privately Produced Public Goods
There is only a finite number of ways of
distributing property rights on a given total
environmental use between the traders so that
the market equilibrium is Pareto efficient

Typically efficiency requires that those with fewer
endowments of private goods should have a
higher allocation of property rights on the public
goods

Chichilnisky, 1992-3
Chichilnisky and Heal, 1993
Chichilnisky, Heal and Starrett, 1993-4

Management (CCRM)

Simple Example of a Market with
Privately Produced Public Goods
Two Countries, i=1,2

Two Goods:
one private: x

one public: a = abatement = - emissions

Initial data:
(1) technology φ (a) = x, and
(2) property rights on the use of the public good,
ai , i=1,2 Σ ai = a

Management (CCRM)

Each Country solves the following problem:

(*) Max ui (xi ,a),

Such that
xi = φ (ai)+π ( ai – ai), φ’ < 0

where π is the market price of x relative to a ,
namely the “permit” price

At a World Market Equilibrium each country
maximizes utility (*), and all markets clear
i i
Σ ai = Σ ai = a
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2 nations market equilibrium trading a private and a public good

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New Economic Findings

 Efficiency in trading permits requires
more emission rights to developing
countries

 Why?

Management (CCRM)

Market Equilibrium: two nations trading two
goods – one private and one public

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Experiments with
GREEN MODEL

Show that the world cost
of abatement is lower
when the South is given
proportionately more
permits
Management (CCRM)

Experiments with Columbia-Green
model:
 General equilibrium model with
permit markets
 12 regions
 12 by 12 international trade matrix
 8 sectors
 Experiments lead to similar finding,
i.e. equity and efficiency are
connected
Management (CCRM)

Sensitivity analysis of the OECD-
PIR global model shows that it is
more efficient to allocate somewhat
more permits to developing
countries
 Currently the N-S per capita difference in
emissions is 6:1
 IN the case of U.S. the difference is 10:1
 Developing countries with more than 86%
of the world population emit less than
70% of the total carbon emissions
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Present Value of Real Income Loss over 2000-2050
(in percentage deviation relative to BaU)
INDIVIDUAL UNIFORM GRAND POPULATION MIXED
STABLILITY TAX FATHERING BASED

USA -O.79 -0.90 -0.76 -2.94 -1.84
JPN -2.41 -1.24 -1.83 -2.84 -2.34
EEC -1.23 -1.16 -1.22 -3.13 -2.19
OOE -0.58 -0.55 -0.54 -1.53 -1.04
EEX -3.39 -0.83 -0.78 0.09 -0.39
CHN -3.88 -3.47 -4.14 6.02 1.04
FSU -1.42 -2.66 1.08 -7.13 -2.92
IND -2.61 -2.00 -2.94 14.62 7.00
EET -0.33 -1.09 0.81 -5.94 -2.51
DAE -0.29 0.16 0.20 0.19 -0.05
BRA -1.60 -1.78 -4.40 -0.55 -2.45
ROW -0.40 -0.01 0.05 0.21 0.12
WORLD -1.65 -1.16 -1.17 -1.06 -1.07

Management (CCRM)

This is because each dollar of
investment yields more output in
the South

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Management (CCRM)

TODAY

 There is a general agreement that
making accessible more development
funding for poor countries in a
controlled and incremental fashion
could benefit the world economy as a
whole

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TODAY
 There is a general agreement that
something must be done at the
international level

 Kyoto, December 1997 COP was a
turning point

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Yet in the global negotiations, the
division between industrial and
developing nations is as deep as ever

There is a general agreement that
without bridging North-South gap there
will be no real progress

How to move ahead?

Management (CCRM)

 One way to ensure this is to follow a
simple rule: the countries that emit
less receive somewhat more permits:

A “reverse grand-fathering”allocation

 Repeated across time, such a policy
would compensate those who use the
atmosphere judiciously and provide
incentives to abate

Management (CCRM)

The Key Issues
•Allocation of rights on the use of the
atmosphere

•This is a question of efficiency as
well as equity

More on this in the next lectures

Management (CCRM)

How to resolve
the China-US Impasse

• New Financial Mechanisms:
Bilateral Options
(Chichilnisky: Time Magazine 2010)

•Carbon Negative
Technologies
Management (CCRM)

Technology Transfer

•Negative Carbon Market

•To increase clean energy

• Reduce carbon in the atmosphere

Management (CCRM)

New Financial Mechanisms:
Bilateral Options
the Green Power Fund
•
•Based on Carbon Market

• Replicating Article 4 of UNFCCC

• North and South get what each
wants
Management (CCRM)

Resolving the Global
Environmental Crisis

The following lectures develop

solutions

Management (CCRM)

Pegram Lecture 2, August 10, 2012

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Pegram Lecture 2, August 10, 2012