The Economics of Copenhagen by Nouriel Roubini

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As global leaders begin meeting in Copenhagen to craft a new climate change deal, we take a look at what sort of deal might emerge, what different countries are bringing to the table and the likely economic costs of such a deal. This piece is excerpted from a longer piece, "The Economics of Copenhagen," available in full to RGE clients.

Despite lowered expectations for the meeting, climate change mitigation, emissions reductions and clean technology have already benefited from more political firepower and government incentives than at any time in the past. In part, this reflects a growing acceptance of the economic and financial benefits of technological change and energy efficiency as countries seek out the next sources of growth. The thorniest issues at Copenhagen concern who will finance the transition to a lower carbon economy.

Expectations for a grand climate bargain were brought to earth in mid-November, when leaders meeting on the sidelines of the Asia-Pacific Economic Cooperation (APEC) suggested that a grand bargain seemed out of reach in 2009. Global leaders are now pushing for a two-step process including a non-binding “political” Copenhagen deal for 2009, which would include a new financing structure that would be followed by an agreement with legally-binding provisions in 2010. This would give national governments enough time to ratify the agreement before the Kyoto protocol expires in 2012. The "nonbinding political agreement” activists hope will be brokered at Copenhagen would set a goal for reducing global emissions by aggregating national and multilateral targets and allocating funds to developing countries for mitigation efforts.

It’s no surprise that divisions abound when 192 countries are at the table. Even including some of the larger blocks, the current negotiating platforms are difficult to compare, with countries using different base years and setting a range of intermediate and long-term goals. Concerns include the scale and scope of cuts; the mechanisms that would test whether or not cuts have been made; the approval of offsets; and, most importantly, the means of financing. Despite the renewed interest in and enthusiasm for clean technologies and stopping climate change, the domestic economic benefits from carbon-intensive industries suggest that a politically-binding deal will be difficult to broker. These challenges seem likely to linger into 2010, particularly if the global economic recovery is sluggish and staggered, and trade protectionism rises.

Key Debates

There are two major areas of debate: the distribution of emissions cuts around the world to meet a global target, and the allocation of the cost of these measures. Financing the transition to a lower carbon economy is Copenhagen’s make-or-break issue and without an agreement on how the bill will be paid, an agreement on emissions targets is unlikely. In the days leading up to December 7, most major economies presented new and improved emission-reduction plans to strengthen their bargaining positions. However, these plans are not necessarily comparable to each other. Nor are there agreed-upon monitoring systems that will assess whether countries are in compliance. Moreover, the developed economies expected to pick up the tab for mitigation and adaption efforts are still recovering from severe recessions and are wary of any deals that could disproportionately benefit trading partners.

Many developing economies are reluctant to commit to emissions targets that would restrain their economic growth, preferring instead to commit to reducing the carbon intensity of growth. Doing so should lead to lower emissions than if no changes were made, but the pace of emissions growth could still be substantial. Given the pace of development and the still-low car use per capita, hydrocarbon use is set to increase. At the same time, countries like the U.S. are worried that higher emissions standards would further encourage the outsourcing of goods production to countries where carbon-emission regulations are not as stringent.

Yet the rising long-term costs of carbon-based energy are prompting governments and companies to look for new systems of production. Even unilateral programs like carbon taxes, government support and Cap-and-Trade systems are helping businesses plan for future costs. For governments acting unilaterally or in concert, consistency of policy will be necessary.

Emission Targets a Sticking Point

Countries have been at loggerheads over an agreeable emissions target for some time. On average, developing countries expect a greater reduction from developed countries (at least 40% from 1990 levels by 2020). Developing countries, which are themselves quite different in terms of economic and emissions growth, contend that global caps on emissions pose a risk to economic growth. Countries like India and China point out that already-industrialized economies were able to freely pollute during comparable points in their development. Yet domestic pressures within these countries, and from other emerging markets, particularly those most vulnerable to rising sea levels, are prompting policy changes.

The Copenhagen talks come right as the global economy emerges from recession, underscoring the mixed links between the economic and financial crises and climate change mitigation. On one hand, the sharp fall in industrial production around the world has reduced emissions sharply in 2009, making it easier to meet long-term goals. Additionally, governments seized opportunities to support new industries, and provided incentives to increase energy efficiency with fiscal stimulus projects. The effects of these “green stimulus” measures were mixed, with few jobs created, but they did, especially in the U.S., partly offset a reduction of private capital to clean technology ventures. However, with government budgets deteriorating sharply, particularly in the G7, allocating funds to reducing carbon emissions abroad will be a tough sell.