New Zealand is currently reconsidering how its forestry sector can contribute to meeting its long-term climate change targets, and what this means for its emissions trading scheme (NZ ETS). A recent paper from researchers at Motu Economic and Public Policy Research and the Environmental Defense Fund sheds light on New Zealand’s innovative treatment of forestry in the NZ ETS, its impacts so far, and questions about where to go from here. Read More
The climate crisis requires not only urgent action, underpinned by a robust framework of proven economic-driven solutions to effectively address its multifaceted challenges. Given the increasing urgency, we need economists at the forefront, conducting rigorous research and informing policy decisions. Recognizing this critical need, the Economics team at EDF is dedicated to nurturing economists who are eager to contribute to the climate fight.
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This post draws from a chapter for a book I wrote in 2020: “Overcoming the tragedy of distance – cooperating with our friends’ friends” in Living with the Climate Crisis ed. Tom Doig. Bridget Williams Books, Wellington, New Zealand
I believe that finding ways to work more intensively and effectively with people with very different resources, cultures and life experiences is critical to rapid global decarbonization.
For me, the unprecedented challenge from climate change is that most mitigation has to occur in countries with fewer resources. Key high-emitting countries such as India, China, Indonesia and Brazil, as well as smaller countries such as Laos, Ethiopia, and Peru are all projected, in business as usual forecasts, to have rising emissions as they develop.
These countries have strongly competing priorities, as they also need to address poverty or resolve internal conflict. They are unlikely to mitigate greenhouse-gases fast enough without help. Yet, to stabilize the climate, those countries and all others must reduce their emissions to net zero and the faster the better.
Models by EDF(2019, pp. 200-232) and IETA(2019) suggest that we could double the amount of global carbon dioxide mitigation to 2035 with no extra cost if richer countries can support emerging and developing countries effectively, but that’s hard. ‘International trading’ of mitigation, where richer countries, or their companies, support developing countries to reduce their greenhouse gas emissions, has long been a goal, but it has not yet lived up to its promise.
We will all benefit if we can resolve this together. I also think those of us with more resources owe it to poorer countries to help; they are the most vulnerable to climate change, to which they have contributed little. It seems deeply unfair to also expect them to bear the full burden of their transition to net-zero.
Tragedies of climate change
Humans however often struggle with cooperating and sharing with people who are far away from them, in either a physical or social sense. I struggle to empathize with people in India whom I will never meet, but who will need support when they replace coal-fired power plants with renewables as India moves toward net-zero emissions. I don’t think I’m alone in this and I imagine they feel the same about people like me who are not taking rapid action on climate change even when we can afford it.
Is our fundamental problem in mobilizing resources to support developing country decarbonization this “tragedy of distance?”
“Tragedies” are situations where we humans are brought down by our own flaws. These tragedies make climate change particularly challenging to address.
The “tragedy of the commons” suggests that if we can’t exclude people from use of a common resource, we are doomed to destroy it through overuse. For example, the fish stock in a particular area isn’t destroyed because people can’t see what is happening, but because if others are going to over-fish, whatever one individual does, it is in each individual’s personal interest to go fishing while the fish are still there. They feel they can’t protect it. That’s a self-fulfilling prophecy.
The “tragedy of the horizon” suggests that individual and collective myopia and selfishness lead us to take actions now although they will cause our future selves and future generations to suffer. The phrase was coined by Mark Carney (Former Governor, Bank of England) for climate change, but another classic example is most countries’ inability to invest enough of the wealth that they extract from non-renewable minerals, like oil, to sustain their citizens’ well-being in the future. Again, we can see this coming but struggle to avoid it.
These tragedies are not inevitable. Some communities solve them impressively (e.g., the many examples from the work of Nobel Prize winner Elinor Ostrom and her colleagues, or Norway’s Sovereign Wealth Fund). Others find partial solutions. New Zealand avoids the worst problems of overfishing by limiting catches through the Quota Management System, a system which, though imperfect, has now lasted for more than thirty years. Humans also have relatively good ‘institutions’ for making intergenerational decisions. Families tend to have strong bonds for at least a couple of generations. We may not make “efficient” decisions for our own future selves and our descendants, but we do, generally, care.
Climate change is an issue where all tragedies—of distance, of the commons, and of the horizon—are fully engaged. Climate change is global and cumulative, with extremely long-term, long-lived impacts. Although it is now clear that people alive today are already experiencing the impacts, the major benefits from our mitigation actions today will be experienced not by older people like me, but by our children and grandchildren.
We have worked hard for nearly thirty years to build institutions at the international, national and local level to coordinate mitigation efforts. We need to keep doing this. Despite our lack of obvious success so far, we have made considerable progress. However, these approaches depend very much on a hierarchical approach. That approach is appealingly elegant and logical in responding to a global problem, and is a critical part of the solution, but it’s not working fast enough. And having only one coherent institutional approach is inherently fragile.
We need both coordination and cooperation
United Nations climate agreements try to replicate the success of economic institutions in managing human activity. However, in contrast to institutions that aim to address climate change, many international economic institutions, such as those that govern commerce and banking are essentially addressing a coordination problem. Their success is not easily replicated when dealing with a global cooperation problem like climate change.
Maybe the approaches of more traditional and Indigenous societies have something to offer us as a complement. These societies have broad networks of relationships that extend into the natural world and rely on these and shared belief systems rather than institutions to manage goals and conflicting interests. Traditional ways of thinking of Māori, the Indigenous people of New Zealand, contrast strongly with the hierarchical assumptions about how humans relate to each other and the natural world, “the Great Chain of Being,” common in much contemporary Western thought.
Can we harness shared belief systems and existing North-South relationship networks and reduce the tragedy of distance? Could that help us build deep collaborations among small groups of countries to support the large-scale transfers of resources needed for efficient global climate action?
Is it better to think about transfers to support mitigation in developing countries as primarily about establishing networks of relational contracts, and the strong communication and trust that supports them, rather than centralized carbon commodity trading systems where all have to trust one system?
Shanghai Bund skyline landmark ,Ecological energy renewable solar panel plant
The announcement by President Xi Jinping at the UN General Assembly last month makes me optimistic.
First, on its own, achievement of this goal will contribute to a reduction in expected future temperature by 0.2 to 0.3 degrees.
Second, having a clear and ambitious end goal will shift the narrative within China from incremental slowing of emissions growth and reductions in some sectors to a focus on how emissions can be eliminated entirely (or close to it).
A vision of transformation toward a low-emissions China will complement the vision of a “Beautiful China.” Pollution control efforts are highly complementary with climate mitigation actions – e.g. moving to renewable energy from fossil fuels, restoring ecosystems – and can dramatically improve the wellbeing of the Chinese people. A clear and attractive vision can mobilize a wider community to seek and implement the multitude of small and large changes needed. It will increase confidence in the future of China’s new national ETS, the strengthening of which will almost inevitably need to be part of China’s strategy. That confidence will make the ETS more effective by generating realistic prices and greater certainty for investors.
Third, it changes the climate cooperation ‘game’, significantly.
Economists think of climate cooperation as a game because each player’s (in this case country’s) decisions depends on what they think other players/countries will do – like chess, or rugby. China’s latest ‘move’ responds to others’ earlier moves and anticipates and will influence later ones. Global cooperation on climate change is hard, because of temptations to free-ride. We can use game theory to explore ways to improve humanity’s odds of a good outcome. We know that humans can sometimes cooperate when it’s a repeated ‘game’ – we get many chances to try to cooperate, observe others, reward or sanction and then try again.
And it’s not a binary outcome where we either win or lose. Any level of cooperation is better than nothing. It might be optimal to aim for no more than 1.5 degrees above pre-industrial temperatures but even if we don’t achieve that, 2 degrees would be better than 2.5 degrees.
Cooperation is easier when some players take leadership, and that’s what China has done. They are not the first emerging economy to set a net-zero target (Bhutan, Chile, Costa Rica, Fiji, the Marshall Islands and South Africa are examples of others), but China’s size makes its announcement a game changer in several ways. The Chinese have shifted the focal point for emerging country contributions to a more ambitious level.
In addition, the rewards to other countries from helping to encourage and sustain China’s efforts rise – if they act in ways that lead China to draw back from this commitment there is more to lose. The costs of mitigation will fall as China learns and shares its new knowledge and technology. Finally, there is less risk that efforts to lower emissions in one country will lead to movement of high emitting-activity to China thereby having no global impact.
Fourth, it means that China, a really large player, will now need to engage even more seriously in helping less developed countries accelerate their mitigation.
Reaching net-zero will be much easier for the Chinese if they can buy high-quality internationally transferable mitigation outcomes (new United Nations Paris Agreement language for international credits). Their engagement in this market could firm up the rules and, critically, mobilize the skills and financial and technical resources that the poorer countries who could credibly sell such credits will need to embark on their own transformational emission reductions journeys.
As China mitigates more aggressively domestically it will develop technology and know-how that it can also export, as it has already on a smaller scale. Some exports will be particularly useful for countries where lower-cost Chinese technology, such as electric buses or cars might be more attractive than expensive European or North American ones. China’s Belt and Road Initiative offers a critical mechanism that can be turned to this purpose. If China can help poor countries develop strong mitigation policies, through strong South-South cooperation, they could transform global cooperation further and strengthen markets for this technology. This would make me even more optimistic.
Strong emissions trading system prices encourage and facilitate climate action but also reflect private sector confidence in governments’ commitments to long-term transformation.
Every evening in my Brooklyn neighborhood we come out onto our stoops with our children, dogs, bells, horns and pots (my contribution – inspired by the Colombian cacerolazos I witnessed protesting – non-violently, though I can’t say quietly – in Bogotá). We make a big noise to thank and celebrate the generosity and selflessness of the medical personnel and essential workers who are keeping life going during the crisis. Their example is an inspiration to us all and reminds us that humans are at essence a cooperative species. This same spirit of cooperation, backed up by strong social and political institutions including effective emissions trading systems, can help protect our climate in these difficult times.
Our focus now must be on flattening the curve, caring for the sick and vulnerable, and then getting back to work. But as we recover from this crisis, we need to do so in a way that helps us confront the next one: global climate change. Lawmakers in many countries are beginning to pivot from relief to recovery, focusing on the longer-term work of getting the economy back on track. We need that economy to have low greenhouse gas emissions.
No one should take false hope from the temporary decline in greenhouse gas emissions we have seen recently. In the short term, when economic activity falls, pollution falls. During the financial crisis of 2007-9 global greenhouse gas emissions did drop, slightly and briefly. The current economic crisis is deeper but will also pass and when it does, so too will the dip in climate pollution.
To make declines in emissions permanent, we need to seize this moment of fundamental change to ensure effective, efficient, resilient policies to lock in economic and behavioral shifts that do contribute to a transition to a low emission future where all people thrive.
One key element of the policy mix in an increasing number of countries and jurisdictions is an Emissions Trading System. These systems limit greenhouse gas emissions while allowing flexibility around where and when emissions occur. They provide price signals to help guide clean investment and other climate actions. The limit, or cap, controls emissions; the marginal cost of achieving that limit, which depends on technology and other climate policies among other things, drives the ETS price.
What drives emission prices?
Those ETS price signals have been affected by COVID and its economic consequences. The climate challenge is no less urgent, but is the private sector feeling less pressure from governments to act? Are the canaries who sing in the healthy cooperation mine falling quiet?
Initially both the European Union and New Zealand ETS prices dropped dramatically, but they have since clawed back much of their initial losses. Will they recover and even move to levels consistent with modeled estimates of prices required to stabilize the global at less than two degrees above pre-industrial levels? A recent survey by IETA suggests not. It finds private sector expectations of emissions prices over the next 10 years have fallen relative to expectations a year ago by 12% (EU and the Western Climate Initiative (WCI) – California and Quebec), 27% (Regional Greenhouse Gas initiative), and 35 – 38% (New Zealand and Mexico). What does this mean?
During a recession, when capital is scarce, because ETS units are assets their price will also tend to fall in a similar way to other assets. As the financial sector recovers, asset prices should also recover. These price adjustments, like those driven by new information about mitigation technology provide useful signals. However, general economic factors and new information about the true costs of achieving our climate goals are not the only drivers of these changes in prices.
Because an emissions trading system is a market created by regulation, the price in each ETS is deeply dependent on expectations about the future stringency of that regulation. Because allowances in emissions trading systems are ‘bankable’ (they can be saved for future use by those who emit less and hence surrender fewer allowances today), as long as there is a ‘bank’ of units available their price depends on what people expect demand and supply will be in future, not just on current scarcity. That makes ETS prices a barometer of both the stringency of policy that politicians are willing to implement—and also of the private sector’s expectations about how stringent policy is likely to be over the long term.
In 2008 there was some international optimism about climate action. The Kyoto Protocol had come into force in 2005; obligations began in 2008. Climate policies were gaining traction in many countries. The EU emissions trading system started its second phase with a healthy price, and New Zealand’s ETS kicked off with similar prices. These reflected that optimism. In the US, the Regional Greenhouse Gas Initiative held its first auction in 2008, and California was moving forward after passing the ambitious Global Warming Solutions Act in 2006. But by December 2009, the price of carbon allowances in the EU emissions trading system had fallen, partly as a result of economic contraction, and more importantly things were beginning to fall apart internationally starting with an unsuccessful U.N. Climate Summit in Copenhagen. By the end of 2012 emission prices had largely collapsed (though prices in the California ETS, launched one year later, were protected by a price floor). Recession was not the only driver, and it’s always hard to disentangle various causes, but the financial crisis did not help.
After the financial crisis and recession, the private sector clearly did not believe that policy makers would impose stringent caps in emissions trading systems; this kept prices low. Optimism around government-led climate action had evaporated. Emission prices, and the signals they provide to investors and companies, only really recovered after 2016 in New Zealand and 2018 in Europe. We can’t wait that long again.
How we can protect climate action from shocks like COVID
Recessions don’t have to lead us to fall even further behind in addressing climate change. The way we manage ETS can help protect the continuity of climate efforts and returns on clean investments against short-term loss of confidence in governments’ commitments to climate cooperation. Possibly the smaller shifts in expectations of prices in the EU and in California and Quebec reflect their more mature institutions and price management approaches—the Market Stability Reserve in the EU and the auction price floor in California and Quebec. Market players have more confidence that the institutions will manage short-term shocks. Critically though, they also have more confidence—though still not enough—that these jurisdictions have a sustained commitment to real long-term change.
When ETS participants believe in society’s commitment to long-term, transformational change to low emissions, ETS prices will reflect only the cost of achieving that.
Recent reductions have come at an enormous cost to human wellbeing. This is not what a transition to a low-emissions economy looks like. The good news: there is still time to stop climate change in ways that allow people and nature to prosper together, and human well-being to burgeon. But the window for such action is rapidly closing. We need a positive and attractive transformation, not economic crises that cause distress and bring only temporary reductions.
We can’t avoid the worst impacts of climate change unless we transform our energy and food systems—changing not only our production but also our culture and the stories we tell ourselves about how we can flourish in balance with our environment. This requires a shift in the fundamental assumptions of all key actors (politicians, business people, officials) and a change in institutions (public and private—e.g. banks, regulations, education, supply chains) so they support of a new set of clean investments and activities and discourage emissions-intensive activities. This won’t happen through forced change. It needs leadership and steady effort.
Once the immediate health crisis from COVID abates we don’t want policy makers (and the public) to lose sight of climate policy and action and focus only on short-term economic concerns. This is what we experienced after 2009 when unemployment levels stayed high long after the global recession passed. We need to find a way to address these critical economic needs while also moving even more aggressively towards a strong, longer-term economic future that offers high wellbeing in a stable climate.
When ETS market players believe we are really on this track, ETS prices will reflect their prediction of the costs of achieving global climate goals—not their assessment of political will. Maybe we are closer than we think. Prices in the EU-ETS recently passed €30 for the first time since 2006 (briefly before falling a little with bad economic news) and NZ-ETS prices have reached their highest level ever around NZ$34 despite the announced closure of a major emitter. I’m optimistic. The canaries are singing again. We need to help them to sing even louder.
I’m from Aotearoa, New Zealand, and I really love its land and people, but I am fully aware that from a global perspective it appears pretty insignificant – that’s actually one of its charms. But being small doesn’t mean you can’t make big contributions including toward stabilizing the climate. This recently published article highlights some lessons New Zealand’s experience with emissions trading can offer other Emissions Trading System (ETS) designers at a time when effective climate action is ever more urgent.
Talking intensively to ETS practitioners and experts around the globe about their diverse choices and the reasons why they made them has made me acutely aware of the need to tailor every ETS to local conditions. In a complex, heterogeneous world facing an existential crisis, diversity in climate policy design makes us stronger and frankly, improves the odds that the young people we love will live in a world where they can thrive.
New Zealand created the second national emissions trading system in 2008, and the system established a number of firsts, some of which have been repeated widely, like output-based allocation of allowances to combat leakage risk. Others offer cautionary tales, like linking a small country’s emissions trading market to a large emissions trading market over which you have little control.
Simplicity helps make an ETS more manageable and effective
New Zealand’s small scale makes simplicity a key virtue. Our regulators are well educated, but there just aren’t many of them. This simplicity would also be a strength in a country with capability constraints, or where corruption is a problem and simplicity naturally increases transparency and reduces opportunities for manipulation.
Regulating fossil-fuel production and imports (that inevitably lead to predictable amounts of emissions – in the absence of effective carbon capture and storage) at the first point of commercialization, another first, made monitoring simple and, in the New Zealand context, minimized the number of regulated agents needed to cover almost 100% coverage of energy-related emissions including all domestic transport.
An ETS needs to match a country’s profile and culture
New Zealand’s small scale and our unusual emissions profile (around half our emissions are biological emissions from agriculture – cow burps and other unmentionables – and lots of land ripe for reforestation) led New Zealand to aim for an ‘all sources – all sectors’ coverage of emission pricing – and this worked well for our politics. In New Zealand ‘fairness’ is a critical cultural value. New Zealand’s ETS covers energy, transportation and industrial process emissions but also deforestation, reforestation, and fugitive emissions from fossil fuel production and landfill waste management. We are still working out how to cover those challenging cows in a way that allows rural communities to thrive – with the current intention being to regulate with emission pricing at the farm level starting in 2025.
The cultural value of fairness also led to a strong linkage between the motivations for free allocation and th methods chosen. Sectors and companies (sometimes pretty much the same thing in NZ) who lobbied for free allocation had to make a logical case that was publicly scrutinized. Lump-sum allocations were given as compensation to those who were losing the value of stranded assets – e.g. owners of pre-1990 forests, including Māori Iwi (tribes) who lost some of the value of forests they had recently received in Treaty settlements when deforestation began to attract carbon liabilities. Output-based allocation is still provided for industrial activities that are emissions intensive and trade exposed and therefore face a risk of leakage of these economic activities to other countries where climate policy is weaker. By effectively subsidizing the activities that might move, output-based allocation reduces that risk.
Political instability can negatively impact markets
Not all experiences have been positive however. As the report highlights, New Zealand’s ETS has suffered from a lack of policy stability and hence lack of emission price stability. This was partly because our emissions price was largely determined by international markets (from 2008 to mid-2015, New Zealand companies could buy and surrender unlimited amounts of international Kyoto units such as those from the Clean Development Mechanism and Joint Implementation). New Zealand’s emission prices bobbed like a cork on the international market. Another critical flaw: not embedding our ETS firmly in a long-term vision for low-emissions transformation and within a wider non-political institutional framework that gives predictability of purpose in the inevitable ETS evolutionary process.
The ability to guide, enable and incentivize dynamic efficiency (e.g. efficient low-emissions investment) has always been a key argument for emissions pricing, but, as a profession we economists have paid too little attention to the political and cultural stability that is critical to enable this. Policy makers need to regularly adapt and update policies. That process of policy evolution can help guide us efficiently through a low-emissions transformation, or, in the face of powerful vested interests and strong temptations to globally free-ride, it can open up repeated opportunities to undermine ambition.
New Zealand is now engaged in the next step of its ETS evolution, learning from others and through critical reflection on our own positive and negative experiences, but continuing to innovate and tailor ETS solutions to our own unusual circumstances. The direct impact on global emissions will be small whatever New Zealand does with its ETS, but the lessons and the example that even small yet significant countries can act and find new solutions, will hopefully help and inspire others.
Kia kaha Aotearoa
