SUSTAINABLE DEVELOPMENT AND MARKET LIBERALISM’S SHOTGUN WEDDING: EMISSIONS TRADING UNDER THE KYOTO PROTOCOL David M. Driesen* Angela S. Cooney Professor Syracuse University College of Law Syracuse, NY 13244-1030 [email protected] (315) 443-4218 May 12, 2007 * J.D. Yale Law School (1989). The author would like to thank Michael Barr, Robert Howse, Nina Mendelsohn, Tom Tietenberg, and the participants in the University of Michigan Legal Theory Workshop for helpful comments, Dean Hannah Arterian for research support, and Molly Curtis for research assistance. Any errors, of course, belong to me. Electronic copy available at: http://ssrn.com/abstract=986145 SUSTAINABLE DEVELOPMENT AND MARKET LIBERALISM’S SHOTGUN WEDDING: EMISSIONS TRADING UNDER THE KYOTO PROTOCOL ABSTRACT This article analyzes the international emissions trading regime at the heart of the world’s effort to address global warming as a means of exploring broader international governance issues. The trading regime seeks to marry two models of global governance, market liberalism, which embraces markets as the model of global governance, and sustainable development, which seeks to change development patterns to protect future generations. This article explores a previously unacknowledged tension between market liberalism’s goal of maximizing short term cost effectiveness and sustainable development’s goal of catalyzing technological change for the benefit of future generations. This article presents new data and theory unsettling the traditional view that market mechanisms encourage innovations vital to sustainable development. Market actors fail to take positive spillovers, e.g. benefits accruing to competitors and thence to future generations, into account in making technological choices. Because of this failure to take long-term economic development into account, the international trading markets have contributed far less to sustainable energy development than more targeted programs. Consideration of these spillovers yields fresh insights. Market liberalism’s ideal of comprehensive evaluation of costs and benefits conflicts with its preference for free markets. Conversely, sustainable development advocates’ tendency to rely on collective decision-making to make difficult technological choices may prove unrealistic. This article unsettles prevailing notions of governance and seeks to stimulate a richer more subtle discourse about the roles of government and markets in addressing global problems. Electronic copy available at: http://ssrn.com/abstract=986145 SUSTAINABLE DEVELOPMENT AND MARKET LIBERALISM’S SHOTGUN WEDDING: EMISSIONS TRADING UNDER THE KYOTO PROTOCOL TABLE OF CONTENTS I. INTRODUCTION................................................................................................................1 II. EMISSIONS TRADING UNDER THE KYOTO PROTOCOL: A PRIMER..................................7 A. Market Liberalism and Sustainable Development.....................................................7 B. Understanding Emissions Trading..........................................................................11 C. Emissions Trading in the Climate Change Regime..................................................13 D. Implementation.........................................................................................................19 1. The European Union’s Emissions Trading Scheme............................................19 2. Alternatives to Global Trading............................................................................21 3. The Emerging U.S. Program................................................................................23 III. TECHNOLOGICAL CHOICES UNDER THE KYOTO PROTOCOL........................................23 A. Technological Choices Generated by Global Emissions Trading...........................24 B. Technological Choices Under More Targeted Programs........................................27 IV. ON THE RELATIONSHIP BETWEEN SUSTAINABLE DEVELOPMENT...............................30 AND MARKET LIBERALISM................................................................................................30 A. Is Expensive Innovation Desirable?: Spillovers and Sustainable Development....30 1. Technological Innovation’s Importance to Sustainable Development................31 2. Positive Spillovers’ Importance...........................................................................34 3. Valuable Innovation May Prove Initially Expensive...........................................37 B. Why Global Emissions Trading Does Not Favor Valuable Innovation...................40 1. Global Emissions Trading’s Failure to Remedy Spillover Neglect.....................40 2. Global Trading Programs Provide Weaker Incentives for Valuable Innovation than Performance Standards of Identical Stringency ...............................................41 C. Implications for Sustainable Development and Market Liberalism.........................49 1. On Sustainable Development’s Relationship to Market Liberalism ...................49 2. Lessons for Environmental Law..........................................................................50 3. Institutional Relationships (of Government and Markets)...................................58 V. CONCLUSION................................................................................................................65 Sustainable Development and Market Liberalism’s Shotgun Wedding: Emissions Trading Under the Kyoto Protocol I. INTRODUCTION An entrepreneur in India wishes to implement a project reducing emissions of greenhouse gases, which trap heat and thereby contribute to global warming.1 She plans to sell credits representing her project’s emission reductions to owners of coal-fired power plants in Germany, who face emission reduction obligations under the Kyoto Protocol to the United Nations Framework Convention on Climate Change (Kyoto Protocol or Kyoto).2 Under the Kyoto Protocol’s emission trading programs, these plant owners can purchase credits reflecting the emission reductions generated by foreign environmental projects in lieu of making all of the required greenhouse gas reductions at their own facilities.3 So, if our entrepreneur develops a suitable project, a European company may pay her for the credits her emission reduction project generates, enabling her to make a profit. 1 See ANDREW E. DESSLER & EDWARD A. PARSON, SCIENCE AND POLITICS OF GLOBAL CLIMATE CHANGE: A GUIDE TO THE DEBATE 8 (2006) (explaining that greenhouse gases warm the earth by absorbing infrared radiation that would otherwise escape into space). 2 December 11, 1997, Report to the Conference of the Parties on its Third Session, 3rd Sess. Pt. 2, Annex I, U.N. Doc. FCCC/CP/1997/7/add.1, 37 I.L.M. 22 [hereinafter Kyoto Protocol]. See generally FARHANA YAMIN & JOANNA DEPLEDGE, THE INTERNATIONAL CLIMATE CHANGE REGIME: A GUIDE TO RULES, INSTITUTIONS, AND PROCEDURES (2004); MICHAEL GRUBB ET AL., THE KYOTO PROTOCOL: A GUIDE AND ASSESSMENT (1999). 3 See Kyoto Protocol, supra note 2, art. 12; Kevin A. Baumert, Note, Participation of Developing Countries in the International Climate Change Regime: Lessons for the Future, 38 GEO. WASH. INT’L L. REV. 365, 383 (2006) (explaining that the Kyoto Protocol’s “Clean Development Mechanism” allows “companies from industrialized countries to . . . receive emission reduction credits from projects based in developing countries.”). See generally David M. Driesen, Free Lunch or Cheap Fix?: The Emissions Trading Idea and the Climate Change Convention, 26 B. C. ENVTL. AFF. L. REV. 1, 27-35 (1998) (analyzing the key language in the Kyoto Protocol authorizing trading). In all likelihood, the producer can only substitute credits for “some” of her reductions, because the Kyoto Protocol requires that trading function as a supplement to domestic reductions. See Kyoto Protocol, supra note 2, arts. 6(1)(d), 12(3)(b), 17. For any particular producer, the extent of permissible reliance on foreign credits will depend upon domestic trading rules implementing the Kyoto Protocol’s “supplementarity” requirement. Let us assume that she faces a choice between two emission reduction projects. One project involves using an end-of-the-pipe technology to control HFC 23, a potent greenhouse gas.4 The other involves installing a new type solar energy technology, a form of renewable energy, thereby avoiding emissions of carbon dioxide, the most ubiquitous greenhouse gas.5 In this situation, our entrepreneur would likely choose the option that produces the cheapest emission reductions.6 Since HFC 23 control usually costs less than solar power installation, she would likely choose the end-of-the-pipe option.7 Is this society’s best choice? 4 See PricewaterhouseCoopers (P) Ltd., CDM Project Design Document: Project for GHG Emission Reduction by Thermal Oxidation of HFC 23 at HCFC 22 Plant of Gujarat Fluorochemicals Limited at 8 (2003), http://cdm.unfccc.int/Projects/registered.html [hereinafter HFC PDD] (describing installation and operation of a thermal oxidation system to control HFC 23 emissions). 5 See Inho Choi, Global Climate Change and the Use of Economic Approaches: The Ideal Design Features of Domestic Greenhouse Gas Emissions Trading and an Analysis of the European Union’s CO2 Emissions Trading Directive and the Climate Stewardship Act, 45 NAT. RESOURCES J. 865, 936 (2005) (explaining that renewable energy reduces emissions by avoiding fossil fuel combustion); WORKING GROUP III TO THE SECOND ASSESSMENT REPORT OF THE INTERGOVERNMENTAL PANEL ON CLIMATE CHANGE, CLIMATE CHANGE 1995 - ECONOMIC AND SOCIAL DIMENSIONS OF CLIMATE CHANGE 241 (James P. Bruce et al. eds., 1996) (noting that renewable energy sources emit little carbon and that switching to them reduces emissions); Kirsten Engel, The Dormant Commerce Clause Threat to Market- Based Environmental Regulation: The Case of Electricity Deregulation, 26 ECOLOGY L. Q. 243, 270 n. 73 (1999). See generally Simone Espey, Renewable Portfolio Standard: A Means for Trade With Electricity from Renewable Energy Sources, 29 ENERGY POL’Y 557, 558 (2001) (explaining that renewable resources are “inexhaustible”). 6 These technological options involve choosing between reductions of two different greenhouse gases. The climate change regime employs scientific assessment of different greenhouse gases’ relative contributions to global warming to create trading ratios, measuring the value of all relevant emission reductions in carbon dioxide equivalents. See Richard B. Stewart & Jonathan B. Wiener, The Comprehensive Approach to Global Climate Policy: Issues of Design and Practicability, 9 ARIZ. J. INT’L & COMP. L. 83, 86 (1992); INTERGOVERNMENTAL PANEL ON CLIMATE CHANGE (IPCC), WORKING GROUP I, IPCC THIRD ASSESSMENT REPORT: THE SCIENTIFIC BASIS, ch. 6, pt. 12, subpt. 2 (2001), available at http://www.grida.no/climate/ipcc_tar/wg1/248.htm. See generally James Salzman & J.B. Ruhl, Currencies and the Commodification of Environmental Law, 53 STAN. L. REV. 607 (2000) (explaining that choosing a common currency for environmental benefits trades can prove problematic). For a potent greenhouse gas like HFC 23, a relatively small amount of reduction can generate a “carbon benefit” (i.e. reduced warming) equal to a relatively large carbon dioxide reduction. For purposes of understanding the text’s hypothetical problem, the reader should assume that both technological options deliver the same amount of carbon dioxide equivalents. Also, this Article uses the term “carbon” in isolation to refer to carbon dioxide equivalents. 7 See Karan Capoor & Philippe Ambrosi, State of the Carbon Market 2006 i (2006), http://carbonfinance.org/docs/StateoftheCarbonMarket2006 (characterizing HFC projects as the “lowest- cost options” and therefore becoming the “first asset class to be systematically tapped globally.”); Xingshu Zhao & Axel Michaelowa, CDM Potential for Rural Transition in China Case Study: Options in Yinzhou 2 Two overarching concepts tend to shape observers’ answers to this question. One concept, that of market liberalism, tends to favor free global markets and the use of economic principles developed to describe ideal markets.8 Another concept, that of sustainable development, emphasizes adequately meeting the current generation’s basic needs while protecting future generations.9 If we view emissions trading as a mechanism that happily marries sustainable development and market liberalism we would assume that society should prefer HFC 23 control, the least cost option. This happy marriage view suggests that selection of a cost effective solution is always a good outcome that provides for sustainable development and allows the free market to work its magic.10 If we reject the happy marriage view, however, the choice of the HFC control option appears problematic. We may believe that free markets tend to favor the current generation’s interests over those of future generations, and that emissions trading markets conform to this tendency. This HFC 23 comes from production of HCFC 22, an ozone- depleting substance used in refrigeration.11 The international community, including India, has agreed to phase out HCFC 22 under the Montreal Protocol on Substances that Deplete the Ozone Layer.12 This HFC project promises a perfectly good greenhouse gas District, Zhejiang Province, 34 ENERGY POL’Y 1867, 1876 (2006) (finding the initial cost of solar installation high, even though over the long term it is cost competitive). 8 See Douglas A. Kysar, Sustainable Development and Private Global Governance, 83 TEX. L. REV. 2109, 2116 (2005). 9 See WORLD COMMISSION ON ENVIRONMENT & DEVELOPMENT (WCED), OUR COMMON FUTURE 8 (1987) (defining sustainable development as development meeting the current generation’s needs without compromising future generations’ ability to meet their own needs). 10 See Baumert supra note 3, at 384 (explaining that the CDM encourages private sector project development to seek out the least cost reductions); cf. David M. Driesen, Markets are Not Magic, 20 ENVTL FORUM 19 (Nov. - Dec. 2003) (discussing the “tendency to view the free market as a magical solution environmental problems”). 11 See HFC PDD, supra note 4, at 8. 12 Sept. 16, 1987, S. TREATY DOC. NO. 100-10 (1987), 1522 UNTS 3; see Menoj Mehrota, Possible Alternative Approaches to Assessing the Baseline Scenario for Destruction of HFC 23 in 3 emission reduction, which would help ameliorate future climate change. But it provides a technological benefit that will only help the current generation, not future generations.13 This facility should shut down anyway at some point and HFC 23 control would lose all value to society.14 The solar technology also reduces greenhouse gas emissions, but this reduction could continue indefinitely15 (unlike the reduction in HFC 23, which only provides a real additional benefit during the HCFC 22 plant’s short remaining life). Moreover, deployment of an experimental solar option might contribute to solving the most important long-term technological problem at the heart of climate change, how to run advanced industrial economies without ever increasing fossil fuel use.16 For burning fossil fuels creates carbon dioxide, the most important greenhouse gas contributing to global warming.17 Also, fossil fuel is a non-renewable resource, meaning that it will the HCFC 22 Industry at 2, http://cdm.unfccc.int/methodologies/inputam0001/ Comment_AM0001_ SRF_071004.pdf (noting that India has ratified the Montreal Protocol with its London and Beijing Amendments and has passed implementing regulations addressing HCFC 22); see also Executive Committee of the Multilateral Fund for the Implementation of the Montreal Protocol, Country Program Update, India at 3, UNEP/OzL.Pro/ExCom/49/37 (2006), http://www.multilateralfund.org/files/49/4937.pdf (stating that HCFC 22 production has gone up in India even while India has phased out other ozone depleters). 13 See Gerard Winn, U.N. Kyoto Chief Judges Climate Change Options, Reuters, May 30, 2006, http://www.alertnet.org/thenews/newsdesk/L30295511.htm (criticizing the HFC 23 reduction project and stating that “the environmental benefits must be clear for future generations.”) 14 Cf. Othmar Schwank, Concerns About CDM Projects Based on Decomposition of HFC- 23 Emissions from HFC-23 Emissions from 22 HCFC Production Sites at 4 (2004), http://cdm.unfccc.int/ methodologies/inputam0001/Comment_AM0001_Schwank_081004.pdf (expressing a concern that approval of CDM credits for emissions associated with HCFC 22 production may create an incentive to delay phasing out this ozone depleting chemical). If one assumes that the carbon credits will create sufficient incentives to keep the HCFC 22 plant open, then the decision to use this option creates a continuing carbon benefit, but creates an ozone depletion cost. Either way, the net societal value of the project may be less than a project that does not involve an ozone depleting production process. 15 See Winn, supra note 13 (recognizing renewable energy as creating “a stable structure” for not emitting CO ). 2 16 See RICHARD A. POSNER, CATASTROPHE: RISK AND RESPONSE 15 (2004) (explaining that breakthroughs in solar technology could help enable a substitution of solar energy for fossil fuels at reasonable cost). 17 See ID. (describing global warming as largely a product of fossil fuel combustion); Richard B. Stewart, Economic Incentives for Environmental Protection: Opportunities and Obstacles, in ENVIRONMENTAL LAW, THE ECONOMY, AND SUSTAINABLE DEVELOPMENT 228 (RICHARD L. REVESZ ET AL. 4 eventually run out.18 If this solar experiment leads to technological developments significantly reducing our reliance on fossil fuels, it may help improve the welfare of the future generations that will need alternatives to finite fossil fuel resources. Thus, the cost effective choice that the market favors may not coincide with the choice that sustainable development considerations favor. This Article examines the question of whether emissions trading marries market liberalism and sustainable development. Douglas A. Kysar has correctly identified this question of market liberalism’s compatibility with sustainable development as a key question for global environmental governance.19 Indeed, responses to this question color perceptions of most environmental and economic issues.20 Therefore, it is not surprising that the relationship between free market and sustainable development ideals has commanded scholars’ attention.21 Emissions trading helps shape perceptions of this relationship. Very few neoliberals (market liberalism advocates) condemn government regulation altogether.22 Instead, most neoliberals support regulatory reforms that employ market concepts to EDS. 2000) [hereinafter ENVIRONMENTAL LAW] (characterizing carbon dioxide as “the most important” greenhouse gas). 18 Cf. POSNER, supra note 16, at 59 (recognizing that fossil fuel resources are finite, but arguing that they may not be finite relative to human demand because prices will rise when they become scarce). 19 See Kysar, supra note 8, at 2114-18 (discussing the rise of market liberalism and international interest in sustainable development). 20 See generally Barbara Ann White, Economic Efficiency and the Parameters of Fairness: A Marriage of Marketplace Morals and the Ethic of Care, 15 CORNELL J. L. & PUB. POL’Y 1, 2 (2005) (discussing “the great divide” between scholars “using theories of welfare maximization derived from the study of market[s]” and those more concerned about equity). 21 See, e.g., Kysar, supra note 8, at 2118-2147 (describing tensions between market liberalism and sustainable development); WILLFRED BECKERMAN, A POVERTY OF REASON: SUSTAINABLE DEVELOPMENT AND ECONOMIC GROWTH xii (2003) (an economist arguing that the sustainable development ideal is not ethically superior to the “economist’s goal of maximizing the sum of human welfare over future generations”); GEOFFREY HEAL, VALUING THE FUTURE: ECONOMIC THEORY AND SUSTAINABILITY (1998); HERMAN E. DALY, BEYOND GROWTH: THE ECONOMICS OF SUSTAINABILITY (1996). 22 See Kysar, supra note 8, at 2120 (noting that neoclassical economics does support some regulation). 5 shape environmental regulations.23 These reforms include wider use of cost-benefit analysis (CBA) to determine environmental regulation’s goals and of emissions trading to meet these goals.24 The international embrace of emissions trading under the Kyoto Protocol suggests that emissions trading may qualify as the most widely accepted neoliberal environmental reform.25 Hence, if a marriage exists anywhere, it should exist in the realm of emissions trading under the Kyoto Protocol. This article claims that markets neglect positive “spillovers” associated with technological choices, i.e. benefits that do not lead to increased rents for the firm making the choice, which are crucial to sustainable development. If introduction of a new solar technology inspires technological advances by competitors, for example, this creates a positive spillover. This article aim to show that positive spillovers are vital to addressing global climate change and shine new light on our understanding of market liberalism, sustainable development, and environmental law. Part one of this Article provides needed background, introducing the concepts of market liberalism and sustainable development, explaining emissions trading, and providing a primer on the climate change regime. It emphasizes emissions trading’s role in seeking to cement a union between sustainable development and market liberalism ideals. The second part presents data on technological choices under the Kyoto Protocol, like the choices our entrepreneur faces. The data raise questions about whether global 23 See Thomas O. McGarity, The Expanded Debate over the Future of the Regulatory State, 63 U. CHI. L. REV. 1463, 1492 (1996) (describing “economic efficiency” as the “guiding light” for “free marketers”). 24 See id. at 1491-97 (explaining that “free marketeers” favor CBA and market-based mechanisms); see, e.g., Robert W. Hahn & Robert E. Litan, 8 J. INT’L ECON. L. 473 (2005) (arguments by the American Enterprise Institute’s co-founders for CBA). 25 The term neoliberal describes a world view embracing broad reliance on global markets and supporting economic concepts, i.e. the view embracing market liberalism. See Kysar, supra note 8, at 2116. 6 emissions trading spurs technological innovation that aids sustainable development. The third part uses the concept of positive spillovers to explore this data’s implications for environmental law and for the relationship between sustainable development and market liberalism. II. EMISSIONS TRADING UNDER THE KYOTO PROTOCOL: A PRIMER A. Market Liberalism and Sustainable Development Market liberalism embraces free markets and a set of economic concepts that provides ideological support for neoliberal reforms.26 The economic concepts generally stem from efforts to describe, not justify, markets. But many of those employing these concepts, especially in the law and economics movement, use them to justify market- based solutions to problems.27 In general, economists tend to evaluate all policies and decisions in terms of efficiency, and leading law and economics scholars, most prominently, Richard Posner, have argued that efficiency constitutes an important goal for government policy.28 While true devotees of free markets may prefer no regulation at all, most of those employing economic concepts to justify markets recognize the need for some regulation.29 Economists generally presume that markets are efficient only when they generate no “externalities,” costs or benefits not reflected in prices.30 They characterize the harms pollution causes as “negative externalities,” e.g. as costs not reflected in market 26 See id. at 2116 (identifying market liberalism with a “neoliberal political philosophy” and “cultural exaltation of the market”). 27 See, e.g., POSNER, supra note 16, at 201 (claiming that economics is both normative and positive). 28 See RICHARD A. POSNER, THE ECONOMICS OF JUSTICE (1983); see also Louis Kaplow v. Steven M. Shavell, Fairness v. Welfare, 114 HARV. L. REV. 961 (2001). 29 See McGarity, supra note 23, at 1484-1513 (contrasting “radical anti-interventionists” opposing nearly all government regulation with other neoliberal groups that support reformed regulation). 30 See David M. Driesen, The Societal Cost of Environmental Regulation: Beyond Administrative Cost-Benefit Analysis, 24 ECOLOGY L. Q. 545, 552-53(1997). 7