The stability and effectiveness of international climate agreements : the role of carbon trade, bargaining power and enforcement

Relying on individual countries’ efforts to reduce greenhouse gas (GHG) emissions is insufficient for keeping the rising global average temperature below a level detrimental to humans. Instead, the threat of climate change requires global cooperative efforts to reach significant reductions in GHG emissions. Yet, it is difficult to reach a consensus on sharing the burden of climate change mitigation among nation states because of the free-riding incentives resulting from the public good property of climate change mitigation. In the absence of a supranational agency that takes the role of an enforcer of commitments, the compliance with mitigation commitments is also an obstacle to mitigation cooperation even after an international climate agreement (ICA) has been signed and ratified. To enable effective GHG emissions mitigation, the design of institutional and economic instruments that can facilitate the formation of ICAs is needed. The aim of this thesis is therefore to study the stability and effectiveness of ICAs by considering the impacts of carbon trade, countries’ uneven bargaining powers and enforcement mechanisms. Game theoretical modelling is a useful and appropriate tool to study the incentive mechanisms applied to agents with different preferences, and is often used to study the formation and stability of ICAs. Hence, game theory applies throughout this thesis. To relate the analytical solutions to the real problems in ICAs formation and thus to provide policy insights, numerical models and analyses are also employed and presented in this thesis. While Chapter 1 sets the scene and formulates the research questions, Chapter 2 develops a four-stage coalition formation game in order to study the impact of a carbon market on regional incentives to join an ICA for GHG emissions mitigation when the carbon market is established independently of this agreement. This carbon market, which is assumed to be formed after the mitigation coalition, is open to the mitigation coalition and its outsiders. In particular, the initial emissions permit choice of each participant in the carbon market is based on an endogenous permit choice mechanism introduced by Helm (2003). The impact of this carbon market on incentives to join the mitigation coalition and the interlinkages between the two coalitions are studied. Results show that number and size of stable mitigation coalitions are smaller with than without a carbon market. The intuition is that in the presence of a carbon market, players are faced with more strategic choices implying that members of the stable mitigation coalitions have a potential incentive to deviate from a mitigation coalition and become a carbon trader instead. This can destabilise the mitigation coalition. Because the carbon market offers an alternative or complementary policy instrument to facilitate mitigation, some non-signatories to the mitigation coalition would join a carbon market which helps to reduce global emissions. However, the mitigation coalition has no incentive to join a carbon market with non-signatories, since the benefits from free riding surpass the net gains from carbon trade. It is concluded that even with this dual-agreement system, free-riding incentives prevail and global cooperation does not emerge. Chapter 3 develops a model of an international carbon market where allowances are endogenously determined by each member of a carbon trade agreement, but with an exogenous constraint on the number of allowances per member. A global model is used to explore the incentives for regions to participate in such a carbon market and to examine its performance. Results show that the stability and effectiveness of an international carbon market can be improved by imposing constraints on individual allowance choices compared to a carbon market without such constraints. Constraints on allowance choices reduce “hot air” and increase global welfare and mitigation. Under a relatively lax constraint (12% below BAU emissions in the STACO calibration), a carbon market with the largest membership can be formed. When tightening the constraint the stable carbon markets become smaller but perform better in terms of global abatement and welfare. If the constraint is too tight, however, no stable carbon market can be formed. Moreover, numerical results also demonstrate that by tying individual allowance choice constraints to the Nash-emissions levels, international carbon markets are more successful in terms of global welfare and abatement, as it responds better to individual incentives to participate. Hence, a revision of the baseline could ease current climate negotiations, where BAU emissions are still dominant for defining and negotiating abatement targets or emission allowances. Chapter 4 studies the impact of using the Nash bargaining solution (NBS) for distributing coalitional gains under different sets of bargaining weights on the stability and effectiveness of international climate agreements. International climate negotiations are modelled as a Nash bargaining game in which cooperative gains are distributed based on the NBS with asymmetric bargaining power. In climate negotiations, asymmetric countries’ bargaining powers are unequal and may be driven by different characteristics of the players. By discussing and reviewing potential reasons that could induce differences of negotiators’ bargaining power in international climate negotiations, five different factors that determine negotiators’ bargaining power are identified: i) discount factor; ii) abatement efforts; iii) abatement costs; iv) climate change damages; v) economic power. Numerical results illustrate that the Nash bargaining solution can improve the participation incentives and performances of ICAs as compared to those that do not redistribute gains from cooperation, but its capacity to overcome free-riding incentives is limited. The success of international climate agreements depends on the set of bargaining weights that matters in climate negotiation. Among five sets of asymmetric bargaining weights, the one determined by negotiators’ economic power can facilitate a climate coalition that comprises two of the largest emitters (China and United States) jointly with two other regions (High Income Asia countries and Brazil). In climate policy making multiple determinants of bargaining power will play a role. This is because countries’ incentives to cooperate on GHG mitigation are impacted in a complex way by factors that are related to abatement options, climate change vulnerability and economic power. Hence, the bargaining power of each negotiator is likely to be driven by multiple determinants. Our model can be extended in a straightforward manner to account for different interlinked drivers of bargaining power if these can be determined. Chapter 5 studies the design of an optimal enforcement mechanism for a self-enforcing ICA and the impact of an optimally designed enforcement mechanism on participation and compliance. The model is formulated as a sequential cartel formation game, in which the coalition chooses an enforcement policy comprising an abatement target, monitoring expenditures and fines. Individual signatories respond by choosing their preferred abatement level which may or may not comply with the target. In equilibrium, signatories’ compliance levels are determined by individual welfare maximization under the agreed enforcement policy. Considering partial compliance, it is demonstrated that the extent of compliance depends on abatement targets, monitoring expenditures (the intensity of monitoring) and the fine. Results show that the compliance level of a coalition member can always be improved by increasing the monitoring expenditure. However, the effect of the target on compliance levels depends on the structure of the fine function. The coalitional best abatement level can be induced as a joint result of the monitoring expenditure and the target when the fine function is quadratic. Because monitoring is costly, full compliance will usually not be enforced. As to the stability, a “broad” and “deep” climate coalition cannot be formed with a costly enforcement mechanism. Four conclusions can be drawn from this thesis. First, establishing a carbon market outside of a mitigation coalition may not help to improve countries’ incentives to join the mitigation coalition, while the global mitigation level can be increased because the carbon market offers an alternative or complementary policy instrument to facilitate mitigation. Second, imposing a constraint with moderate degrees of strictness on initial allowance choices can increase the mitigation effectiveness and participation level of an international carbon market. Moreover, changing the baseline of the constraint from the BAU emissions level to the non-cooperative Nash level can also be considered a way to improve the success of an international carbon market. Third, factors that could influence bargaining powers of negotiating countries can be brought up and determined at pre-stage of international climate negotiations. Hence, policy designers for negotiations of ICAs may consider to use the determinants of bargaining power that can enhance large emitters’ bargaining position to improve the mitigation effectiveness of ICAs. Fourth, due to the existence of free-riding incentives in the process of compliance with mitigation commitments, an optimally designed enforcement policy is needed for the successful implementation of ICAs.