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Market Failure
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Read the
article on
Kyoto, and answer the questions
associated with it.
Economics
of the Kyoto Protocol
Erica Schneider
ECEEM 100
December 10, 1999
Introduction
Global warming has been one of the most controversial pollution issues in recent
time. Perhaps even more controversial are the debates over mitigation. One
proposed plan is the Kyoto Protocol and it entails a global strategy to reduce
greenhouse gas emissions in an attempt to slow the process of global warming.
This paper will deal primarily with an economic analysis of the Kyoto Protocol,
drawing from an article that appeared on Time.com, “Why There’s More Hot Air
About Global Warming.”
Global Warming
Gases in the atmosphere absorb a large percentage of the energy radiated by the
Earth. This process of energy storage called the greenhouse effect, keeps our
climate such that life as we know it is able to flourish. Without such a
retention in energy, the Earth would be nearly 33o C cooler. In such a climate,
nearly all of the water on Earth would be ice and conditions would be
drastically different. The key gases involved in the greenhouse effect are water
and carbon dioxide.
Although the greenhouse effect is necessary for life, the problem is that recent
increases in the amount of carbon dioxide emitted have caused more heat than is
normal to be trapped near the Earth’s surface. While the Earth does undergo
periodic warming and cooling trends, the current warming trend seems to have
progressed much more quickly than previous warming trends. It has been
hypothesized that the increased warming rate is due to larger amount of carbon
dioxide that has been emitted into the atmosphere since the Industrial
Revolution. Combustion of fossil fuels, such as coal and oil, paired with
deforestation are the main reasons for so much carbon dioxide in the atmosphere.
As a result of the increase in the combustion of fossil fuels, carbon dioxide
levels in the atmosphere will double in the next 25 years. This could possibly
cause a 1.5o to 4.5o C change in the global temperature. Associated with this
shift in climate is the possibility of a 1 to 5 meter rise in ocean levels,
which would destroy many coastal areas and impose a huge economic cost. Changes
in agricultural production due to a shift in climate might also be very costly.
The ecological imbalances that may occur could trigger the extinction of many
species. A high existence value is placed on the species that would die off,
thus adding an additional cost.
1)
How might the
costs of global warming be estimated?
(7 marks)
It is noteworthy that global warming is only one
of the current theories about the climate change of the planet. Some scientists,
such as Patrick Michael from the University of Virginia, would argue that global
warming would actually be beneficial because the temperature increases would
warm the planet at night and thus increase the growing season. Still others
would argue that the planet is actually in a global cooling.
The Kyoto Protocol
In December 1997, representatives from nearly 166 nations meet in Kyoto, Japan
to discuss a global strategy for a reduction in the emission of greenhouse
gases. The intention of the treaty is that although the costs of unabated
climate change may be difficult to quantify, it is necessary to provide a
meaningful incentive for countries to lower their emissions of carbon dioxide
and other greenhouse gases. The fundamental logic is that the effort must be
global in nature, as otherwise individual nations would not have the proper
motivation for lowering their consumption of fossil fuels.
The representatives present agreed to a 5.2% reduction from 1990 global
pollution levels by the year 2012. The treaty has yet to be ratified by the
majority of the world’s industrial nations, including the United States. Out of
the 166 countries represented at the meeting only 34 had agreed to it by
September 7, 1998. This poses a problem for proponents of the Kyoto Protocol
since the treaty will be ineffective without the support and participation of
industrial leaders.
There are many that feel the treaty must be market based and flexible in order
to work. Nations are more apt to agree to international regulation if it less
costly and if results can be achieved in an efficient manner. In October 1999,
150 of the nations involved in the climate change treaty meet in Bonn, Germany
to discuss technicalities of fulfilling the requirements of the treaty. Among
the options considered was a plan to institute a system of tradable permits3 as
discussed by Tony Karon in “Why There’s More Hot Air About Global Warming.” The
permits would allow heavily industrialized countries to buy pollution “credits”
from those nations whose pollution levels are under the quota imposed by Kyoto
Protocol. This would allow pollution abatement to be a tradable good and promote
the economy while enforcing the treaty.
2)
Explain how a
system of tradeable pollution permits would be likely to work.
(5 marks)
3)
Evaluate the
strengths and weaknesses of such a system in dealing with global CO2 emissions.
(8
marks)
Market Failure Associated with
Climate Change
When firms or on the larger scale, nations, emit large volumes of greenhouse
gases as a byproduct of production, they are imposing a cost on others. The
pollution, in theory, leads to a warmer climate, which causes various
environmental problems. The market, however, fails to reflect the actual cost of
the damage to the environment in the price that is charged. The price of a given
good, such as steel, is cheaper and supplied in greater quantities than it would
be if the market truly took account of costs. If the market was forced to
account for the additional costs imposed, the price would be higher and smaller
quantities would be produced.
4)
Using a
diagram, explain why "The price of a given
good, such as steel, is cheaper and supplied in greater quantities than it would
be if the market truly took account of costs"
(7 marks)
The pollution associated with theory of climate change is a classic example of
market failure in the form of an externality. When the market does not achieve
optimal results, a market failure occurs. An externality is a market failure
that results when the consequences of an economic action spill over to affect a
third party. This commonly occurs where property rights are ill defined. The
property rights involved with the emission of greenhouse gases are difficult to
define because no one actually owns the air.
Additionally, the clean air and more temperate climate that result from
correcting the pollution externality are public goods. A public good is non-rivalrous
and non-exclusive. Because clean air is a non-exclusive and others cannot be
deprived of it, there is an incentive to free ride on the effort of others. That
is, one company has an incentive to free ride on the efforts of another
company’s emissions abatement. Similarly, in the global community, one nation
has the incentive to free ride on the efforts of other countries to control
greenhouse gas emissions. A public good is under-supplied in the market because
individual firms and nations receive no benefit from their actions if everyone
else simply relies on them.
5)
How far do
you agree with the idea that clean air is a public good?
(4 marks)
6)
Explain why
the free rider problem is a potential Achilles heel to the Kyoto Protocol. How
might the free rider problem be prevented?
(8 marks)
Government Failure Associated with
the Kyoto Treaty
As there are many different theories regarding whether or not global warming is
occurring, there are distinctly different market failures associated with the
Kyoto Treaty depending on which theory is correct. First, I will present market
failures associated with the treaty if global warming is occurring, followed by
failures associated with the treaty if global warming is not occurring.
If global warming is occurring, then the treaty has interesting public choice
implications. The benefits of the treaty are very widespread in that everyone
living on earth will presumably benefit from cleaner air and by maintaining
slowing down the rate at which our planet warms. The costs, however, are much
more concentrated in industries were fossils fuels are necessity and on the
consumers that purchase such products. The costs will disproportionately fall on
industrialized nations, while all nations will reap the benefits. As a somewhat
smaller group, industrialized nations are more likely to be more organized as to
rejecting the treaty since they will bear the majority of the costs. As a larger
group, the remainder of the world’s nations are not as likely to be as organized
and as vocal about promoting the treaty.
Additionally, the shortsightedness effect comes into play. The goals of the
treaty do not go into effect until 2012, which is four election cycles from now.
Since politicians are primarily concerned with election results it is unlikely
that a successful party will be enthusiastically promoting this treaty. The
costs would be high for industry and consumers and therefore, it will not be
popular to support a treaty that will incur such costs on the electorate.
Different public choice implications arise if global warming is not occurring.
If the treaty is not really needed to stop the effects of global warming, it can
be interpreted as an international effort at income redistribution. The costs
are sufficiently spread out amongst all of the world’s consumers, yet the
benefits are highly concentrated to a much smaller group. It is not entirely
clear which small group would benefit from this treaty, although green power
suppliers and unindustrialized nations seem likely to benefit largely from this
agreement. Even though it has not yet been determined that global warming is not
happening, voters are likely to go along with whatever policy is in place due to
rational ignorance.
7) Explain
why " green power suppliers and unindustrialized
nations seem likely to benefit largely from this agreement"
(6
marks)
Conclusions
As with any government policy, economic costs and benefits must be examined when
attempting to legislate ways to reduce the emission of greenhouse gases and
mitigate the effects of global warming. In this situation, the costs and
benefits are difficult to quantify, as global warming is only a theory. Whether
or not it is actually occurring factors heavily into the analysis of costs and
benefits. The market failure associated with global warming is an externality
and the government failures deal with public choice implications. An economic
resolution of these market and government failures relies on whether or not the
earth is warming. Once science determines what is actually going on, the
situation can be more effectively addressed.
8) Using the
case as a starting point discuss whether the strengths and weaknesses of the
free market model as a method of resource allocation.
(15 marks)
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