Meeting the Kyoto Targets: The Importance of Developing Country Participation

Abstract

Many studies have emphasized the importance of China's participation in combating global climate change, but they looked at the role of China mainly from the point of view that future, uncontrolled increases in CO2 emissions in China will offset all emissions reductions in industrialized countries. This is only one side of the story. Although politicians and policy analysts claim the importance of China's participation in lowering compliance costs of industrialized countries, no studies have quantified such an importance to support their claims. This study is the first one to disentangle the impacts of China on industrialized countries' compliance costs from those resulting from the rest of the world by examining the markets with and without the inclusion of China, thus giving other side of the story.

In so doing, we start with the no emissions trading case where each industrialized country must individually meet its Kyoto targets. Next, we consider a case where trading of emissions permits is limited to industrialized countries only. We then expand the scope of the market to include all the developing countries but China. Finally, to investigate the role China plays in bringing down industrialized countries' compliance costs, we further broaden the market to include China into full global trading.

Our results clearly demonstrate that the gain of the OECD as a whole increases as the market expands. Depending the scenarios examined, the U.S. would gain 12-19% with the inclusion of China than without China. Our results also show that developing countries themselves benefit from such an expansion too because it not only provides them for additional financial resources, but also helps to cut their baseline carbon emissions by a big margin. By contrast, the former Soviet Union tends to become worse off as the market expands. The potential conflict of interest between the former Soviet Union and developing countries underlines the importance of establishing clear rules of procedure about admitting new entrants before emissions trading begins. Furthermore, our results show that China is expected to emerge as the world's number one host country for clean development mechanism projects, but to materialize such benefits, China faces great challenges in institutional setting and implementation strategy.

Keywords: Emissions trading, clean development mechanism, greenhouse gases, marginal abatement costs, price of permits

JEL Classification: Q28, Q25, Q48, Q43