G‐20 and Climate Change: Achieving Comparable Effort Through a Carbon Price Collar

Warwick J. McKibbin,
Warwick McKibbin
Warwick J. McKibbin Former expert - Economic Studies, Center on Regulation and Markets, Distinguished Professor of Economics & Public Policy - Crawford School of Public Policy, The Australian National University

Adele Morris, and
adele morris
Adele Morris Former Senior Fellow - Economic Studies
Peter J. Wilcoxen

September 17, 2009

The below is one in a series of recommendations to G-20 leaders on how to construct their policies so that the world economy progressively gains in strength while the long-run health of public finances does not threaten the recovery process.

Climate negotiations are currently at the
forefront of global policy debates. Leaders
at the G-20 Summit in Pittsburgh should
focus on the challenges associated with the negotiations,
how the recent economic crisis has aff ected
countries on meeting emission targets, and how
to move global climate policy forward. If effective,
these discussions could be infl uential in implementing
coordinated policy agreements at the 15th annual
United Nations climate change conference in
Copenhagen in December.

Policy Considerations

The key to advancing global climate policy is in the
United Nations Framework Convention on Climate
Change (UNFCCC) 2007 Bali Plan of Action. The
Plan highlights the need to ensure the “comparability
of efforts” across developed countries while
“taking into account differences in their national
circumstances.” Implementing these goals will require
a modified approach to the negotiations that
goes well beyond the Kyoto paradigm. The Kyoto
Protocol focused on establishing national emissions
targets measured as percentage reductions relative to
a specified base year. However, differences in economic
conditions can easily mean that countries
with similar targets will experience very different
costs, violating the goal of comparable effort. Indeed,
variations in economic growth among developed
countries between the Kyoto base year (1990)
and the date at which it was to go into effect (2008)
have led to large differences in emissions growth
and, consequently, in the costs of meeting the Kyoto
targets. To ensure comparability of effort, the new
agreement implemented in Copenhagen will need
to address costs directly. A transparent and robust
method for doing so would be to include upper and
lower bounds on the price of carbon dioxide emissions,
a policy often described as a “price collar.”

Expanding the agreement to include a price collar
would have additional benefits as well. It would
provide a path for rapidly industrializing countries
such as China and India to take on gradually increasing
commitments without fearing that their
growth will be stifled. It would also help stabilize
the agreement in the face of major economic disturbances
such as the recent financial crisis and global
economic downturn. The agreement will need to
endure through many economic and political crises,
and a price collar would help it do so.

A collar would supplement the emissions targets already
under negotiation. It would require that each
party undertake at least a specified minimum level of
abatement effort, even if the country’s target could
be achieved with less. In addition, each party would
be allowed to exceed its target if it could show that
it was unable to comply in spite of undertaking a
high level of effort. Specifically, in addition to a cumulative
emissions target for the 2013 to 2020 period,
major economies would agree on three things,
known collectively as the “price collar”:

  1. A starting floor price on a ton of carbon dioxide-
    equivalent emissions for 2013;
  2. A starting price ceiling on a ton of carbon dioxide-
    equivalent emissions for 2013; and
  3. An annual rate of growth in the price floor and
    ceiling that reflects the real rate of interest, such
    as 4 percent.

To be in compliance, each party would demonstrate:
(1) that it had imposed a price on carbon-equivalent
emissions no lower than the floor over most or all of
the commitment period, and (2) that its cumulative
emissions were no higher than its announced target
OR that its price on emissions had reached the
ceiling for an appropriate proportion of the commitment
period given the extent of its excess emissions.

This approach has several advantages. The ceiling allows
each party to comply even if its target turns
out to be unexpectedly stringent and impractical
to achieve. The floor ensures that no party’s commitment
is unduly lax; it reduces the incentive for
parties to negotiate overly-generous targets; and it
limits the downside risk for investors in low-carbon
technologies by guaranteeing a minimum payoff per
ton of emissions avoided. Both aspects of the collar
help to reduce the risks faced by investors, which
will accelerate the development and diffusion of
new technology.

A price collar also accommodates developing countries
like China that are uncomfortable with hard
emissions caps but might be open to imposing a carbon
tax. Such countries could adopt a price floor—
possibly without an emissions target at first, or with
a low price ceiling—and then gradually transition
to commitments more like those of industrialized

Several implementation details would need to be
negotiated, including guidelines for demonstrating
compliance with the price collar. This would include
methods of verifying the carbon price and the extent
to which the price was effective. Emissions above
the cap would need to be accompanied by an appropriate
duration of prices at the ceiling and allowances
transacted at that price.

The price collar could be implemented by each party
in a manner most suitable for its domestic economy.
A tax or cap-and-trade system would provide
a transparent carbon price. However, regulatory
measures could also be used via provisions for calculating
an equivalent carbon price. For example,
countries could calculate a shadow price on emissions
analogous to the way the World Trade Organization
converts trade protection policies into tariff
equivalents. Parties could include existing fossil energy
taxes when determining their compliance with
the price floor, but such credit would have to be net
of any subsidies to fossil energy or other greenhouse
gas emitting activities. Each party would control any
revenues generated by its domestic climate policy.

Some environmentalists are uncomfortable with a
price collar because they believe that any limit on
carbon prices would undermine the effectiveness of
the agreement. However, without a price collar, parties
to an agreement may be reluctant to undertake
aggressive policies and may insist on loose caps, or
none at all, rather than risk excessive stringency or
non-compliance. Moreover, without a price ceiling,
volatile macroeconomic conditions may cause countries
to abandon the agreement entirely, a considerably
worse outcome than allowing them to exceed
their targets briefly.

Action Items for the G-20 Summit

Focusing exclusively on reductions from historical
emissions has greatly hampered climate negotiations
to date, especially in regard to the role of developing
countries where uncertainty about future
growth and abatement costs is greatest. Combining
a clear cumulative emissions target with a price collar
would balance the environmental objective with
the need to ensure that commitments remain comparable
and feasible. Further, the price collar can
ease major developing countries into the system
by allowing them to adopt only a price floor in the
early years. The G-20 Summit is the right group of
countries meeting at the right time to steer global
climate negotiations in a direction of comparable effort
implemented through a price collar rather than
by focusing on emissions targets alone.

Note: This paper is a shortened version of W. J.
McKibbin, A. Morris and P. Wilcoxen (2009) “A
Copenhagen Collar: Achieving Comparable Effort
through Carbon Price Agreements” published
by the Brookings Institution. The views expressed in
the paper are those of the authors and should not
be interpreted as reflecting the views of any of the
above collaborators or of the institutions with which
the authors are affiliated.