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ADDRESSING POLICY CREDIBILITY PROBLEMS FOR LOW-CARBON INVESTMENT
Gregory F. Nemet, La Follette School of Public Affairs, University of Wisconsin-Madison, +1-608-265-3469, nemet@wisc.edu
Michael Jakob, Mercator Research Institute on Global Commons and Climate Change, jakob@mcc-berlin.net
Jan Steckel, Mercator Research Institute on Global Commons and Climate Change, steckel@mcc-berlin.net
Ottmar Edenhofer, Mercator Research Institute on Global Commons and Climate Change, director@mcc-berlin.net
Overview
Several characteristics of the climate change problem make policy credibility crucial for private incentives for low-carbon investment. The long lifetimes of CO2 in the atmosphere and of energy infrastructure require a long-term perspective. Decarbonizing the global economy involves investments in novel technologies that depend on policy for payoffs. Because these policies entail short-run costs and only yield benefits at a later stage, policy makers frequently favor shifting these costs to the future, which results in time-inconsistent policies ADDIN EN.CITE Gerlagh201555485548554817Gerlagh, ReyerMichielsen, Thomas OMoving targetscost-effective climate policy under scientific uncertaintyClimatic ChangeClimatic ChangeClimatic ChangeClimatic Change519-529132420152015/10/01Springer Netherlands0165-0009http://dx.doi.org/10.1007/s10584-015-1447-610.1007/s10584-015-1447-6English1.
Credibility problems are well established in the climate policy literature, with previous work pointing to the costs of weak credibility ADDIN EN.CITE Bosetti201130033003300317Valentina BosettiDavid G. VictorPolitics and Economics of Second-Best Regulation of Greenhouse Gases: The Importance of Regulatory CredibilityThe Energy JournalThe Energy Journal1--2432120112, the role of the long term ADDIN EN.CITE ADDIN EN.CITE.DATA 3-5, and the importance of perceptions ADDIN EN.CITE Bosetti201137833783378317Bosetti, ValentinaFrankel, JeffreyPolitically Feasible Emissions Targets to Attain 460 ppm {CO$_2$} ConcentrationsReview of Environmental Economics and PolicyReview of Environmental Economics and Policy2011December 14, 2011http://reep.oxfordjournals.org/content/early/2011/12/14/reep.rer022.abstract10.1093/reep/rer0226. A particular focus has been the effect of credibility on carbon prices ADDIN EN.CITE Dinan201240574057405717Dinan, TerryStocking, AndrewU.S. Cap-and-Trade Markets: Constraining Participants, Transactions, and PricesReview of Environmental Economics and PolicyReview of Environmental Economics and Policy2012July 29, 2012http://reep.oxfordjournals.org/content/early/2012/07/29/reep.res004.abstract10.1093/reep/res004Koch201454795479547917Koch, NicolasFuss, SabineGrosjean, GodefroyEdenhofer, OttmarCauses of the EU ETS price drop: Recession, CDM, renewable policies or a bit of everything?New evidenceEnergy PolicyEnergy Policy676-6857320140301-42157,8 and the consequent need for complementary policies ADDIN EN.CITE ADDIN EN.CITE.DATA 9,10.
However, less attention has been paid to the question of how persistent uncertaintyboth about the problem and potential solutionsnecessitates reacting to new information. Climate policy design needs to navigate a tradeoff between making commitments that are sufficiently credible to stimulate transformation and retaining flexibility to adjust ADDIN EN.CITE ADDIN EN.CITE.DATA 11-14. This trade off however is quite familiar in other policy areas, such as monetary policy.
As a further complication, long time horizons and deep uncertainty combine to provide political actors with strong incentives and ample opportunities to influence the policy process, potentially undermining incentives for low-carbon investment. Many actors with heterogeneous stakes are involved and policies will create winners and losers ADDIN EN.CITE Carraro201255575557555717Carraro, C.Favero, A.Massetti, E.Investments and public finance in a green, low carbon, economyEnergy EconomicsEnergy EconomicsS15-S28342012Nov0140-9883WOS:000311656100004<Go to ISI>://WOS:00031165610000410.1016/j.eneco.2012.08.03615. Hence, for policies to be efficient in the long run, policy makers need to consider second best solutions taking into account the limitations of governments.
Methods
The goal of this paper is to generate a broad set of possible remedies for addressing credibility problems and then characterize the advantages and disadvantages of each. First, we review the theory and practice of addressing credibility problems in monetary, fiscal, and trade policy. Second, we apply this framework to assess how credibility is addressed in the Nationally Determined Contributions (NDCs) agreed on within the United Nations Framework Convention on Climate Change (UNFCCC). Finally, we set up a taxonomy for evaluating policy alternatives in terms of their effect on incentives for investment in low-carbon technology.
Results
The experience from monetary, fiscal, and trade policy points to the crucial roles that expectations about future policy play in affecting the incentives of economic actors. In each of these cases, there is a trade-off between strong commitments associated with tying future policy makers hands with rigid rules and the weaker incentives allowing discretion to react to new information. Tools they have used include announcing general targets that allow for some flexibility, allocating discretion to independent authorities rather than elected officials, and making use of reputational effects. In particular, we emphasize the importance of (1) monitoring and review, (2) clearly defined safeguards, and (3) distributional policies that allow creating winners and compensating losers.
Based on these insights, we develop a taxonomy of policy alternatives to address credibility issues in climate policy. For each alternative we summarize the advantages and risks. We aim to include a broad set of policies to span the spectrum between policies prioritizing flexibility and those prioritizing commitment. A primary objective is that elucidating these aspects of these policy instruments allow for various weighting on characteristics to account for heterogeneous political, legal, and other contexts. In many cases, applying a combination of these approaches may be preferable. We summarize the alternatives with the following table:
In our review of the UNFCCC NDCs, a preliminary assessment shows a distinct contrast between countries combining high ambition with few specifics (Nigeria) and those with more modest targets but quite detailed plans to meet them (Mexico). The UNFCCCs recent agreement to take stock of commitments every five years is a policy innovation with potential to address credibility problems.
Conclusions
In a concluding section, we summarize implications for national and international policy design. For example, acknowledging heterogeneity and dynamism in countries means that optimal policy combinations could vary. In contrast, some policy combinations may seem especially attractive and robust to differences in national contexts. We also include hypotheses amenable to empirical work and provide other directions for future research.
References
ADDIN EN.REFLIST 1 Gerlagh, R. & Michielsen, T. O. Moving targetscost-effective climate policy under scientific uncertainty. Climatic Change 132, 519-529, doi:10.1007/s10584-015-1447-6 (2015).
2 Bosetti, V. & Victor, D. G. Politics and Economics of Second-Best Regulation of Greenhouse Gases: The Importance of Regulatory Credibility. The Energy Journal 32, 1--24 (2011).
3 Convery, F. J. ReflectionsThe Emerging Literature on Emissions Trading in Europe. Review of Environmental Economics and Policy 3, 121-137, doi:10.1093/reep/ren020 (2009).
4 Dietz, S. & Stern, N. Why Economic Analysis Supports Strong Action on Climate Change: A Response to the Stern Review's Critics. Review of Environmental Economics and Policy 2, 94-113, doi:10.1093/reep/ren001 (2008).
5 Bhringer, C. Two Decades of European Climate Policy: A Critical Appraisal. Review of Environmental Economics and Policy, doi:10.1093/reep/ret018 (2014).
6 Bosetti, V. & Frankel, J. Politically Feasible Emissions Targets to Attain 460 ppm {CO$_2$} Concentrations. Review of Environmental Economics and Policy, doi:10.1093/reep/rer022 (2011).
7 Dinan, T. & Stocking, A. U.S. Cap-and-Trade Markets: Constraining Participants, Transactions, and Prices. Review of Environmental Economics and Policy, doi:10.1093/reep/res004 (2012).
8 Koch, N., Fuss, S., Grosjean, G. & Edenhofer, O. Causes of the EU ETS price drop: Recession, CDM, renewable policies or a bit of everything?New evidence. Energy Policy 73, 676-685 (2014).
9 Ulph, A. & Ulph, D. Optimal climate change policies when governments cannot commit. Environmental and Resource Economics 56, 161-176 (2013).
10 Faehn, T. & Isaksen, E. T. Diffusion of Climate Technologies in the Presence of Commitment Problems. The Energy Journal 37 (2016).
11 Brunner, S., Flachsland, C. & Marschinski, R. Credible commitment in carbon policy. Climate Policy 12, 255-271 (2012).
12 Jakob, M. & Brunner, S. Optimal Commitment Under Uncertainty: Adjustment Rules for Climate Policy. Strategic Behavior and the Environment 4, 291-310 (2014).
13 Nemet, G. F., Braden, P., Cubero, E. & Rimal, B. Four decades of multiyear targets in energy policy: aspirations or credible commitments? Wiley Interdisciplinary Reviews: Energy and Environment 3, 522-533, doi:10.1002/wene.116 (2014).
14 Whitesell, W. C. Climate Policy Foundations: Science and Economics with Lessons from Monetary Regulation. (Cambridge University Press, 2011).
15 Carraro, C., Favero, A. & Massetti, E. Investments and public finance in a green, low carbon, economy. Energy Economics 34, S15-S28, doi:10.1016/j.eneco.2012.08.036 (2012).
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