European Affairs

Summer 2001

 

In The News
Beyond Kyoto: a Plan to Bridge the U.S.-EU Gap
William A. Nitze
President, Gemstar Group

 

President George W. Bush and European leaders agreed to disagree on climate control policies during Mr. Bush's visit to Europe in June. The Europeans will stick with the Kyoto Protocol to combat global warming, while Mr. Bush remains steadfast in his rejection of what he regards as a "flawed treaty."

The United States and Europe remain far apart in their basic approach to climate change and environmental regulation, with the Bush administration emphasizing the need to encourage greater energy production by the private sector, and the European Union supporting stronger state action to reduce emissions.

The onus is now on Mr. Bush to come up with an alternative policy to Kyoto that might win international backing. He has said he agrees that global warming is a serious problem that requires a global solution.

It should not be impossible to find an approach that meets economic and political concerns on both sides of the Atlantic.

A U.S. alternative to Kyoto should be built around a domestic "cap and trade" proposal that combines a more realistic and politically acceptable short-term emissions reduction target with a commitment to achieve more far-reaching reductions in the longer term.

The proposed system should include all greenhouse gases so as to reduce its overall cost, be supplemented by other market friendly policies and mechanisms, and maintain a level playing field among established and new energy supply technologies and investments in energy efficiency.

If Mr. Bush were to propose such an alternative, the United States and Europe could close the gap between them by agreeing on a combination of more far-reaching environmental goals, market-based policies for achieving these goals, and a common approach for encouraging deployment of environmentally friendly technologies.

Agreement on more far-reaching environmental goals is the element that poses the greatest challenge to the Bush administration. By rejecting the Kyoto Protocol without proposing an alternative, Mr. Bush has left open the possibility that he does not support any binding target for U.S. greenhouse gas emissions and proposes to rely solely on business-as-usual technological change and voluntary programs.

If the administration did formally adopt such a position, it would isolate the United States in the climate change issue and place a significant strain on its overall relationship with the European Union.

What might be an alternative to this position? An emissions target that would "meet the laugh test" would be to hold U.S. greenhouse gas emissions in 2010 at or below 2000 levels. Such a target might be acceptable domestically since it represents a reduction of 10 percent to 20 percent from the "business-as-usual" scenario, as opposed to the 30 percent to 35 percent represented by the Kyoto target.

Such a proposal would only win international support, however, if it were accompanied by a U.S. commitment to domestic policies and mechanisms that demonstrated seriousness in achieving the revised target and more ambitious long-term emission reduction goals.

Those goals should be consistent with the overall objective of holding greenhouse gas concentrations in the atmosphere below levels that threaten dangerous manmade interference with the climate system as defined by the Framework Convention on Climate Change (FCCC). That convention was signed by the President's father in 1992, and subsequently ratified by an overwhelming majority of the U.S. Senate.

Even these commitments may not be enough to persuade the European Union to reopen the Kyoto Protocol, particularly if the EU convinces Japan and Russia to join it in ratifying the Protocol in its current form.

Both the EU and Japan are currently committed to ratifying and the Europeans are trying to persuade Russia to do likewise. Together, the EU, Japan and Russia account for more than the 55 percent of global emissions required for the Protocol to become effective.

The added element that could give the United States the extra leverage necessary to renegotiate the Protocol is clean energy technology cooperation with key developing countries as contemplated by the FCCC.

The Clinton Administration made efforts to encourage energy efficiency and renewable energy in China, Mexico, South Africa and other developing countries through its development assistance and bilateral cooperation programs.

The European Union has made similar efforts, often accompanied by very low interest loans or other forms of export subsidy for European-made green energy technologies. But these efforts have not achieved sufficient critical mass to move the developing countries onto a less greenhouse gas intensive path.

What is needed to achieve that critical mass is a combination of policies and mechanisms that will encourage large-scale deployment of such green energy technologies in those countries. The most important such policy would be for the United States and the EU to announce more ambitious emissions reduction goals in the long-term.

If the developed countries committed themselves to reducing their emissions of greenhouse gases by 10 percent per decade, starting from 2010 levels and continuing through 2050, they would be aiming at reducing their emissions by over a third by mid-century.

If one assumes an average growth rate for the developed countries during this period of two and a half percent per year, achieving this goal would represent a reduction of over 75 percent in emissions per unit of output.

Commitment by the United States, the EU and other industrial countries to such a long-term goal described above would send a clear signal to the developing countries that they take climate change seriously.

If the United States committed to domestic policies and mechanisms that could achieve the required emissions reductions, and at the same time promised to share new anti-pollution technologies with the developing countries, the developing countries might in turn be willing to announce emissions reduction goals of their own.

But we must take the lead in deploying those technologies within the U.S. economy before they can be expected to deploy them in theirs.

The changes in the global economy implied by such long-term goals cannot be achieved by regulation alone. This is particularly true of the United States. We must use policies and mechanisms that establish binding limits on greenhouse gas emissions and make sure that those limits are observed, while leaving it to the marketplace to determine exactly how the necessary emissions reductions are achieved.

One way of using market-based incentives to achieve emissions reductions is to use taxation to include the environmental costs of emissions in the price of the energy sources that produce them. Higher excise taxes on gasoline and other oil-based transportation fuels, carbon taxes and other types of broad-based energy taxes have been proposed on both sides of the Atlantic.

Unfortunately these taxes have had only limited success in reducing greenhouse gas emissions. Despite imposing some of the highest fuels taxes in the world, the member states of the EU have experienced a higher rate of growth in vehicle miles traveled than the United States over the last twenty years.

High energy taxes are also politically unpopular, as shown by public demands for fuel tax reductions in both Europe and the United States in response to recent oil price increases.

There are three structural problems that limit the effectiveness of energy taxes in limiting greenhouse gas emissions. The first is inelasticity of demand for fossil-based energy in the absence of price-competitive alternatives.

It takes a lot to get people to reduce their demand for personal mobility, lighting, temperature control, electrical appliances and information services, and any elected politician who makes the attempt is unlikely to remain in office for long.

The second is inability to predict the environmental result of a given level of tax because of uncertainties about consumer behavior and other variables. The third is the disproportionate impact of such taxes on poorer people.

These problems can be alleviated by developing price-competitive alternatives to carbon-based fuels and offsetting the regressive impact of energy taxes. But taxation is unlikely to be the primary instrument for reducing greenhouse gas emissions.

Another market-based solution that has broader political acceptance than higher energy taxes is a "cap and trade" system for greenhouse gas emissions. Cap and trade systems involve setting a limit on total emissions and allowing companies to trade emissions permits, so that companies with high emissions can buy permits from more efficient companies whose emissions are below the limit. Such systems have several practical advantages.

They enable policy makers to set a specific ceiling on emissions over a given time period and ensure that it is not exceeded. The additional costs imposed on consumers by such systems are indirect and likely to decline over time.

Most importantly, cap and trade systems have already been used successfully to phase out lead in gasoline and reduce sulfur emissions from power plants. They should be employed in the United States and the EU to minimize the cost of achieving long-term reductions in greenhouse gas emissions.

President Bill Clinton committed the United States to a domestic cap and trade system for greenhouse gas emissions, but failed to present a specific proposal for such a system to Congress and the American public. This failure was a missed opportunity for the Clinton-Gore Administration.

Any cap and trade proposal that contained a specific ceiling consistent with the U.S. target in the Kyoto Protocol, a method for allocating allowances and rules for trading allowances and sharing the benefits of emissions reduction projects in developing countries would have met strong resistance from the fossil fuel lobby and members of Congress sympathetic to its interests. But at least we would have begun a public debate about the specific trade-offs involved in developing a meaningful U.S. climate policy that goes beyond voluntary measures.

A cap and trade system should be accompanied by other measures that encourage use of environmentally friendly technologies. Cap and trade alone has several important limitations.

First, it works best with large stationary sources like power plants, whose emissions are easily calculated and monitored. It works poorly, if at all, with millions of small sources such as automobiles and small diesel generators.

This problem can be minimized by moving tradable allowances upstream to coal mines, refineries, gas plants and other fuel sources. Unfortunately, such an upstream allocation may meet political opposition because it appears similar to a fuels tax.

Second, a cap and trade system in itself does little to overcome market barriers that are impeding deployment of clean energy and efficiency technologies. In the electricity sector, the legacy of state regulation has left utilities without the ability to realize an economic return from their transmission assets by charging rates based on replacement cost. They therefore have an incentive to use their remaining monopoly power over those power lines and distribution systems to favor their own power and services over competing power producers to the detriment of new more environmentally friendly energy sources.

In the buildings and transportation sectors, existing codes and standards are biased against new technologies and do not exploit many opportunities to invest in efficiency improvements that pay for themselves very quickly. Finally a cap and trade system will not in itself cause the public sector to use its purchasing power to drive down the cost of clean energy and efficiency technologies. It should, therefore, be accompanied by other market friendly policies that address these limitations.

A number of separate but complementary policy initiatives should be taken to reduce emissions from vehicles. Minimum fuel efficiency standards for sports utility vehicles, trucks and buses should be raised. Significantly higher fuels taxes could achieve the same result, but given the substantive and political difficulties with such taxes, we shall probably have to rely on higher fuel efficiency standards for vehicles, at least in the short term.

The United States should follow Europe's example by producing cars with advanced diesel engines that promise major efficiency improvements and guarantee high performance.

Vehicles with higher emissions per mile traveled should be subject to a graduated sales tax and vehicles with lower emissions per mile should receive a graduated rebate to provide a point of purchase incentive to purchase cleaner vehicles. Time-of-day highway pricing should be used to reduce congestion-related emissions.

These measures would enable the U.S. transportation sector to hold its carbon dioxide and other greenhouse gas emissions constant or even reduce them over the next decade through fleet turnover alone.

If one makes the conservative assumption that 10 percent of the vehicle fleet turns over every year and that the average new vehicle emits 30 percent less carbon per mile than the vehicle it replaces, the fleet's average carbon emissions per mile would improve by three percent per year.

If growth in vehicle miles traveled can be held to its current rate of less than one percent per year, overall carbon emissions from vehicles would decline at over two percent per year or over 22 percent per decade.

At this rate, the transportation sector could easily meet the emissions reduction targets suggested without being included in a cap and trade system, which could then be limited to larger stationary sources where it works best.

Finally, the government sector has a critical role to play in bringing down the unit cost of low or zero emission technologies through a procurement process that combines many small orders into a large order sufficient to justify construction of larger-scale production facilities with lower unit costs. This is particularly true of photovoltaic and fuel cell technologies, which have great potential for replacing fossil energy but are not yet cost competitive.

If the U.S. Department of Defense put out a request for proposals to deliver 1000 megawatts of zero emission power at a cost not to exceed two dollars per peak watt, for example, it would give the solar industry the opportunity to bid at far lower unit costs than are possible with current production volumes. A similar approach could accelerate the commercialization of fuel cells.

The Bush Administration has made a fundamental error in producing an energy policy in isolation from a climate change policy. The Administration's energy strategy emphasizes increasing the supply of traditional energy sources without considering the need to reduce carbon dioxide and other greenhouse gas emissions.

The elements of the strategy with real horsepower are all focused on removing obstacles to increased production and transportation of fossil and nuclear energy rather than addressing market barriers that impede a transition to a more climate-friendly energy future.

Despite the lip service paid to energy efficiency, the program dollars and proposed efficiency standards that could make a difference have all been cut. Bush has proposed to increase federal funding for research on the science of climate change, but not for research on and deployment of the technologies that might actually reduce U.S. emissions in the long-term.

The Bush Administration will have to change its attitude in order to close the gap between the United States and the EU on climate change. The minimum elements of the new U.S. position should be acknowledgement that climate change is a serious problem and that the United States needs to play a leadership role in addressing it; commitment to a short-term emissions target less stringent than the Kyoto target but ambitious enough to make a difference, combined with more far-reaching long-term emissions reduction goals; announcement of a set of domestic policies and measures along the lines described above; and willingness to negotiate in good faith with the EU and other parties to the Framework Convention on Climate Change.

For the EU's part, the European Commission and the member states must not push the Bush Administration into a corner and thereby make it more difficult for the Administration to develop a more responsible position on climate change. Specifically the EU should be open to a revised short-term target for the United States, provided that the other elements referred to above are included in the U.S. position.

The EU should seek common ground with the United States on developing market-based instruments that will encourage deployment of new clean energy technologies, particularly in the transportation sector. It should join the United States in finding ways to transfer those technologies to developing countries. Finally, it should be prepared to meet the United States halfway on the balance between state action and market forces.

If the United States and Europe can find common ground in their approach to climate change, they can lead the rest of the world in responding to the most serious global environmental issue of our time. If they cannot, an effective global response will be difficult if not impossible.