The world’s leading climate scientists have warned that there are only a dozen years left to save the world from climate catastrophe (2018 IPCC report). Without cooperation, it is almost impossible to constrain global emissions. All countries suffer from the sum total of global emissions, which affect everyone’s climate. But at the same time, each individual country gains by increasing it own emissions, because national GDP is increasing in economic activity and emissions. So each country would like to free ride on others — letting others cut back, while it continues to emit without constraint. The result is called the tragedy of the commons — here, the commons is the global atmosphere and climate, and the tragedy occurs because no individual country has the incentive to cut back on its own emissions. A scheme of cooperation among countries, where all agree to cut back emissions, is required.

The mechanism

In their BSE Working Paper (No. 1084), “Global Unanimity Agreement on the Carbon Budget,” Humberto Llavador and John E. Roemer propose a mechanism based on a unanimous agreement on the global carbon budget that could be useful to frame the climate mitigation challenge. This mechanism should facilitate an agreement upon the allocation of emissions. In their proposal, the decision on the level of carbon emissions is decentralized to the regional or country level, where firms treat their emissions as a production input for which a price is charged. This makes firms internalize the social cost of emissions. The revenue accumulates in a global fund and is returned to global citizens according to national shares that are announced ex ante and that are determined endogenously by the mechanism.

The authors model a simplified global economy and propose a general equilibrium in capital, output, and emissions. Markets for output and capital are standard. Profit-maximizing firms in each country choose the level of capital and the demand for carbon emissions, paying for standard inputs and proposed emissions. The supply of global emissions is agreed upon by country citizenries. In choosing its desired global level of emissions, each country maximizes the utility of its representative citizen, who enjoys consumption from the output but suffers the effects of climate change. Using the latest findings on climate science, warming levels are approximately proportional to cumulative emissions. At equilibrium, all countries agree upon the desired global carbon budget. The price of permits is determined by the supply and demand of carbon emission permits.

An illustration

To illustrate the implications of a global unanimity equilibrium, the authors simulate a 12-region world that negotiate, in the spirit of the Paris Agreement, a climate agreement for 40 years (2015-2055) with the assumption of zero emissions afterwards. The 12 regions correspond to United States, European Union, Japan, Russia, Eurasia, China, India, Middle East, Africa, Latin America, Other High Income countries and Other Asian countries. Each region is endowed with an annual stock of capital, annual production and a carbon intensity parameter that represents annual average values for the period under consideration.

The authors identify utility with the present value of the average annual consumption net of climate change damages. Climate change damages are computed as the monetized present value of warming costs to the end of century. The authors use data from the baseline run in the Regional Integrated Model of Climate Change (RICE). RICE is a computer-based integrated assessment model developed by 2018 Nobel Laureate William Nordhaus. Based on the information in RICE, the authors solve for the global unanimity equilibrium.

Some points are worth to note from these equilibrium allocations:

• Africa, China and India receive half of total revenue from the global fund, being the regions with the highest marginal costs from increases in temperature according to RICE-2010.
• The United States is the largest net contributor, followed by China. These two regions amount for almost 60% of total contributions.
• Africa, India and the small less developed countries in Asia are the only net recipients from the global fund. Africa is by far the largest net recipient.
• The mechanism has an unintended redistributive effect as inequality is reduced across the globe. This follows from the fact that poorer regions are more intensively affected by climate change and hence receive a larger share of total revenue, reducing income differences.

Emission permits are priced at 90$/tC. This should be considered a lower bound as damages are almost surely underestimated in RICE. Total cumulative emissions since the beginning of industrialization amount to 575 GtC, resulting in a temperature increase around 1.3°C above pre-industrial levels by the end of the century. This is below the 1.5°C limit pushed for by UNFCC.

Carbon budget: a better alternative

Despite its potential difficulties, implementing a carbon budget presents several advantages with respect to existing proposals:

• The proposal achieves a globally Pareto efficient allocation in the economy, with decentralized emissions at national level.
• Global supply of permits is determined by unanimous agreement among nations. No central authority sets the global supply of permits.
• The share of the global fund revenues is proportional to the marginal damages from global emissions: countries with higher warming damages receive a larger compensation.
• Insofar as poorer regions are more heavily affected by climate, inter-region inequality falls.

Therefore, the unanimity-agreement-based mechanism proposed by Llavador and Roemer could circumvent some of the cooperation problems that prevent an immediate global action to avoid the most disastrous effects of climate change.