Emissions cap-and-trade as policy?


Prime Minister Yukio Hatoyama, at the United Nations Summit on Climate Change held Sept. 22, stated Japan’s pledge to reduce greenhouse gas emissions (GHG) 25 percent from 1990 levels by 2020, which is premised on “all the major economies” agreeing on ambitious targets.

Other countries applauded the Hatoyama Initiative, with some calling on Japan to take the lead in making drastic cuts irrespective of actions by other major emitting countries.

In this country, various opinions have been expressed over this issue. Whereas environment-related nongovernmental organizations support Hatoyama’s initiative, many elements in the industrial circles who are primarily critical of the cap formulas set under the Kyoto Protocol oppose his plan as technically infeasible.

While some regard the reduction target as feasible if all available policy tools are mobilized to step up technological innovations, others say that eventually it will be necessary only to purchase emission credits from overseas.

Obviously reflected in his proposal is the Japanese government’s strong desire to help promote international negotiations over this problem. But the United States and China, which emit five times as much GHG as Japan does, will likely seek to take the lead. Depending on how the negotiations go, it is conceivable that Japan alone could be forced to accept unfavorable conditions as with the Kyoto Protocol. So, this country needs to make careful preparations.

Hatoyama’s initiative is based on the cap-and-trade system under the Kyoto Protocol of 1997. Consequently, recent environment-related discussions in this country are centered on GHG emission reduction targets such as 25 percent, but will this cap-and-trade formula work as an appropriate policy instrument?

Trading in emissions rights is considered likely to help reduce GHG emissions on the low-cost market. But as long as the energy structure does not change, the allocation of caps on allowable emissions will tend to work virtually with the allocation of energy use. If this is all done on a global scale, market functions are likely to be distorted and the world will move toward a kind of controlled economy.

Before the 15th Conference of Parties to the U.N. Framework Convention on Climate Change (UNFCCC), scheduled for December in Copenhagen, participating countries are stepping up preparatory negotiations for the framework to be set for 2013 and thereafter. There are many difficult problems involving such matters as base year, global allowable emissions, national reduction targets, the improvement of the Kyoto Protocol mechanisms, and the binding power of cap allotments. In particular, developing countries, on the basis of the UNFCCC parties’ general agreement on their “common but differentiated responsibilities” set forth in the convention, are pursuing advanced countries’ historical responsibilities and seeking rigorous emissions cuts and large-scale assistance efforts.

Even if some agreement is made on overall GHG reduction levels, could any reasonable national allocation levels be worked out? Draft measures based on gross domestic product, population and the equalization of the marginal reduction cost are being proposed, but it is very difficult to reach agreement because they are likely to restrict economic activities. If agreement is attained, it will have been made possible through political compromise. If emissions trading takes place as a result, it will mean that political compromise has yielded some economic benefits.

Furthermore, if any particular country should obtain some additional quotas thanks to emissions trading, overall global GHG reduction might not be achieved. Therefore, the cross-border cap-and-trade approach should be limited to the clean development mechanism (CDM), supervised by an international governing organization.

Inside Japan there is considerable room for utilizing trading in emissions rights. If the efforts to reduce GHG emissions are found to be profitable, enterprises will be motivated to innovate technically and make investments in that direction. Transactions done within Japanese territory are neutral to the national amount of emissions reduction.

The allotment of emissions rights to emitters is no easy work. If past emissions records are used as a yardstick, enterprises will tend to delay reduction efforts to increase their amounts of emissions. If the bidding system is adopted, they may curtail production or transfer their operations overseas to avoid being placed at a disadvantage at home due to cost increases.

Recently, in the European Union, there has been the growing tendency to adopt the bidding system for emission rights due to contradictions involved in the allotment system.

In the U.S. the legislative measure to introduce the bidding system mainly in its territory is under deliberation in the Senate in order to secure revenue sources. As a result, the nature of emissions rights has become closer to that of the environment tax; hence the question arises as to whether emission rights trading is more stable than the environment tax as a policy instrument.

Britain’s Committee on Climate Change said in its Oct. 16 report that the price of emissions rights had declined and that it could not expect the price to keep its positive impact felt at the outset. There are some fears that the emission rights market may assume a speculative character and that, if the market becomes unstable, the enthusiasm for emissions reduction will be impaired.

As for measures to address global warming, it is important to try to balance economic growth and conservation. My conclusion is that the pledge-and-review program combined with structural reform measures is the most appropriate solution.

Even under this system it is necessary to set reduction targets for countries on the basis of the world’s allowable total amounts of emissions. Each country is supposed to make political pledges and then take steps to improve energy efficiency, utilize nuclear power, develop renewable energy and reform industrial structures. U.N. member countries and international organizations should review the results, and the countries with insufficient efforts should come under political pressure to make further efforts. This method is easier to obtain international agreement and could make use of market functions.

Internal emissions trading can be utilized and support measures can be adopted in accordance with national circumstances. This method’s regulating impact is mild. If agreement on a rational standard for countrywide distribution of reduction cuts becomes unlikely, this method is the most practical the countries can attain. Yet, if the countries focus on structural reforms, favorable results are bound to come out for both the economy and the environment.

To help developing countries, it is necessary to strengthen the cooperative mechanisms for financial aid and technical assistance. Should all the GHG-emitting countries accept certain burden charges in accordance with their amounts of emissions and provide funds for worldwide development of technology and assistance to developing countries, the integrated power of participating countries would be further strengthened.

The cap-and-trade system may help the EU work out a favorable GHG emissions system by bolstering regional unity, promoting advantageous projects in sync with financial systems, and embracing East European countries, which still have a lot of room for emission cuts. It is necessary for the Japanese again to examine carefully whether this system will become the most appropriate policy tool for the Hatoyama administration from the standpoint of ensuring a fair balance between economy and environment.

Shinji Fukukawa, formerly vice minister of the Ministry of International Trade and Industry (now the Ministry of Economy, Trade and Industry) and president of Dentsu Research Institute, is chairman of the Machine Industry Memorial Foundation.