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December 15, 2009

The Climate Hold–Up at Copenhagen: $60 trillion is up for grabs

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The world's eyes are on Copenhagen, but there we have a problem. The world faces a deadly risk: the risk that we will boil the planet. There is a small chance the threat will go away, but I'm going to take it as read that, faced with a risk that is potentially catastrophic it is prudent to buy some insurance.

This risk, moreover, is a threat to us all -- rich and poor, young and old, black and white and in between. From a common sense perspective, that should make it easy for us all to agree on concerted action. Shouldn't it?

In a number of Hollywood films that I have seen (and enjoyed), a global calamity looms. The American president takes to the airwaves. He tells the world: "Let us set aside our differences and work together." The world listens. Will Smith saves us. The world applauds. The trouble is: This time, it isn't working.

The movie formula works because, in Hollywood, what is required to save the world is heroic action based on personal commitment, skill, and courage. The resources that support the hero are of interest but they are moral and technological; they do not absorb a significant fraction of even one nation's resources. International bargaining is not required.

Climate change, in contrast, puts the world's resources at risk, and cannot be solved without bringing the world's resources into play. Any solution requires multinational commitment, coordination, and bargaining.

Instead of a bargain, at Copenhagen we seem to observe only an agreement to differ. On November 2, 2009, Rajendra Pachauri, head of IPCC, told The Guardian:

I gave all the world's leaders a very grim view of what the science tells us and that is what should be motivating us all, but I'm afraid I don't see too much evidence of that at the current stage. Science has been moved aside and the space has been filled up with political myopia with every country now trying to protect its own narrow short-term interests. They are afraid to have negotiations go any further because they would have to compromise on those interests.

And yesterday I heard a BBC Radio 4 journalist describe the situation brought about by 190 nations each approaching the Copenhagen bargain with their own "red line" requirements as one of "negative negotiating space."

What's happening? How can that be right? In fact, how can it be rational? When human survival is at stake, what are the national interests that can prevent agreement? Isn't our common interest in conserving our shared planetary home the most fundamental interest that we have?

There exists a traditional explanation as to why climate change is hard to manage. In many ways it is a perfectly good explanation. Some call it the "prisoner's dilemma," while others call it the "tragedy of the commons," but the underlying idea is the same. Cutting carbon emissions requires self-restraint. The benefit of my self-restraint is spread over the entire world, so one six billionth of it comes back to me. The cost falls entirely on me, and so exceeds the benefit in a ratio of billions to one.  That is why it suits each person's (or country's) private interest to let other people (or countries) go first in exercising self-restraint.

If others restrain themselves, I won't need to. If they don't, there's no point in it for me. This simple calculus explains why, even in the presence of scientific certainty, the climate problem will not solve itself.

By coming together at Copenhagen, however, the world's nations have an opportunity to take collective charge of this problem, internalize the spillovers, regulate access to the global commons that is our atmosphere, and coordinate on a first-best solution. An agreement is called for, and should be within reach. Why is it so difficult? We need other models to show why.

There is a certain similarity, as I see it, between the Copenhagen problem and what is sometimes called the "hold-up" problem. In the hold-up problem, two parties have relationship based on a shared asset in which both have a stake. The important thing is that this asset is worth more within the relationship than to the outside world. Inside the relationship the asset creates a surplus that is shared between both parties; without the relationship, the surplus would not exist.

There are many analogues for the hold-up problem, including a business partnership and a marriage partnership. In a marriage the "relationship-specific asset" can be knowledge of each other, shared activities, and even children. In a business partnership it can be a technology or way of doing things that is specific to the partnership and cannot be copied to some other use outside the existing business.

Within the partnership, the relationship-specific asset creates a surplus. How will the surplus be divided? In a relationship that works, there are agreed conventions or even (in a lasting marriage, for example) no strict accounting, just a rough sense of give and take. But there is also scope for exploitation. Each party will abandon the relationship if their share of the surplus is driven below zero; at this point, by definition, they would be better off outside. But this also means that one party can aim to appropriate more of the surplus by threatening a break-up, expecting the other to concede rather than lose everything. Each can hold up the other; that is why it is called the "hold-up" problem. This is what happens when children become hostages in a bad marriage, for example.

At Copenhagen, the relationshipship-specific asset is our atmosphere. What is up for grabs in the bargaining is, potentially, the entirely planetary surplus: the excess of global GDP over its unpriced cost: global carbon emissions times the social cost of carbon. How much is that? In 2008, global GDP was around $60 trillion. Global emissions were around 30 billion tons of CO2, or 8 billions tons of carbon. The social cost of carbon is usually put somewhere around $40 a ton, so the total damage is $320 billion, or around half a percent of global GDP. All the rest, more than 99% of global GDP, is the planetary surplus that we produce by exploiting our relationship-specific asset -- our shared planet. This surplus is what we stand to lose if we boil the planet. It is this surplus, $60 trillion less half a percent, that is up for grabs.

This tells us two things. First, the damage that we do to our home by living in it is currently trivial and should therefore be easily fixable. But the scope for redistribution is almost limitless. Effective bargaining can reallocate our entire planetary GDP.

There is one thing in the hold-up problem that we don't have. That is, we don't have an outside option. In the hold-up problem, the power of the exploiter arises from the threat to leave. No country can leave our planet. Where then does bargaining power come from?

Here we go back to game theory -- not to the prisoner's dilemma but to the game of chicken. In the movie Rebel Without A Cause (1955), two teenagers drive at each other on a narrow road. If one swerves, the one to swerve is a "chicken" and loses face. If neither swerves, both lose their lives. As in the game of climate change there is no outside option that does not involve extinction, but the game is played in the hope that the adversary will back down.

A well known result is that, if the game of chicken has a winner, it is the player that shows the most credible commitment. At Copenhagen the rich, poor, and middle income countries are on course for a three-way pile-up, but it is the richest and poorest that are competing to show the greatest commitment.

The commitment of the richest is made credible by two factors: first, unlike the poor, they expect to afford the costs of adaptation, at least for a while, as temperatures and sea levels rise; second, if they give in to bargaining they have the most to lose -- the lion's share of global GDP. The commitment of the poorest, in contrast, arises precisely from the fact that they cannot adapt. Small rises in sea levels, for example, will overwhelm entire nations. They have nowhere else to go -- but also, being the poorest, they have most to gain, in the shape of the same lion's share of global GDP that the richest would like to keep.

No wonder the richest countries approach Copenhagen reluctantly, with trepidation -- and the poorest go there with a glint in their eye. When the poorest countries demand that global temperature increases are limited to +1.5 degrees, they are effectively requiring that the economies of North America and Western Europe are shut down -- immediately. It's not going to happen, but what do the poorest countries have to lose -- and what is there that they can gain instead?

In the middle are China, India, and most middle income countries. They do not have too much to win or lose from bargaining. They can afford a little adaptation to climate change; ultimately they share the common interest of humanity in mitigation of climate change. But they also have least commitment.

To conclude, what makes climate change intractable at Copenhagen is that 190 countries are playing three games at once. Nested within the tragedy of the commons is a hold-up problem. Negotiating the hold-up takes the form of a game of chicken. Perhaps if we all understand this better, it will become easier to solve ...

And a happy Christmas and a prosperous New Year to all my readers!

P.S. Chicken, of course, is a game for teenagers. The adult response is: "Give me the car keys and go and finish your homework!" Don't you wish someone would say that at Copenhagen?

I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).

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