The purpose of this chapter is to examine the major types of policies and measures that can be used to mitigate net concentrations of greenhouse gases (GHGs) in the atmosphere.¹ Alternative policy instruments are described and assessed in terms of specific criteria, on the basis of the most recent literature. Naturally, emphasis is on the instruments mentioned in the Kyoto Protocol (the Kyoto mechanisms), because they focus on achieving GHG emissions limits, and the extent of their envisaged international application is unprecedented. In addition to economic dimensions, political, economic, legal, and institutional elements are considered insofar as they are relevant to the discussion of policies and measures.

Any individual country can choose from a large set of possible policies, measures, and instruments to limit domestic GHG emissions. These can be categorized into market-based instruments (which include taxes on emissions, carbon, and/or energy, tradable permits, subsidies, and deposit–refund systems), regulatory instruments (which include non-tradable permits, technology and performance standards, product bans, and direct government spending, including research and development investment) and voluntary agreements (VAs) of which some fall in the category of market-based instruments. Likewise, a group of countries that wants to limit its collective GHG emissions could agree to implement one, or a mix, of instruments. These are (in arbitrary order) tradable quotas, Joint Implementation (JI), the Clean Development Mechanism (CDM), harmonized taxes on emissions, carbon, and/or energy, an international tax on emissions, carbon, and/or energy, non-tradable quotas, international technology and product standards, VAs, and direct international transfers of financial resources and technology.

Possible criteria for the assessment of policy instruments include environmental effectiveness, cost effectiveness, distribution considerations, administrative and political feasibility, government revenues, wider economic effects, wider environmental effects, and effects on changes in attitudes, awareness, learning, innovation, technical progress, and dissemination of technology. Each government may apply different weights to various criteria when evaluating policy options for GHG mitigation, depending on national and sector-level circumstances. Moreover, a government may apply different sets of weights to the criteria when evaluating national (domestic) versus international policy instruments.

The economics literature on the choice of policies adopted emphasizes the importance of interest-group pressures, focusing on the demand for regulation. However, it has tended to neglect the “supply side” of the political equation, which is emphasized in the political science literature of the legislators and government and party officials who design and implement regulatory policy, and who ultimately decide which instruments or mix of instruments will be used. The point of compliance of alternative policy instruments, whether they are applied to fossil fuel users or manufacturers, for example, is likely to be politically crucial to the choice of policy instrument. And a key insight is that some forms of regulation actually benefit the regulated industry, for example, by limiting entry into the industry or by imposing higher costs on new entrants. A policy that imposes costs on industry as a whole might still be supported by firms who, as a consequence, would fare better than their competitors. Regulated firms, of course, are not the only group with a stake in regulation: opposing interest groups will fight for their own interests.

To develop reasonable assessments of the feasibility of implementing GHG mitigation policies in countries in the process of structural reform, it is important to understand this new policy context. Recent measures taken to liberalize energy markets were inspired mainly by desires to increase competition in energy and power markets, but they can have significant emissions implications also, through their impact on the production and technology pattern of energy and/or power supply. In the long run, the consumption pattern change might be more important than the sole implementation of climate change mitigation measures (e.g. see Chapter 2, the B1 scenario).

Market-based instruments–principally domestic taxes and domestic tradable permit systems–are attractive to governments in many cases because they are efficient; they are frequently introduced in concert with conventional regulatory measures. When implementing a domestic emissions tax, policymakers must consider the collection point, the tax base, the variation or uniformity among sectors, the association with trade, employment, revenue, and the exact form of the mechanism. Each of these can influence the appropriate design of a domestic emissions tax, and political or other concerns are likely to play a role also. For example, a tax levied on the energy content of fuels could be much more costly than a carbon tax for the equivalent emissions reduction, because an energy tax raises the price of all forms of energy, regardless of their contribution to carbon dioxide emissions. Yet, many nations may choose to use energy taxes for reasons other than cost-effectiveness, and much of the analysis in this chapter applies to energy taxes as well as to carbon taxes.

A country committed to a limit on its GHG emissions can also meet this limit by implementing a tradable permit system that directly or indirectly limits emissions of domestic sources. Like taxes, permit systems pose a number of design issues, including type of permit, sources included, point of compliance, and use of banking. To cover all sources with a single domestic permit regime is unlikely. The certainty provided by a tradable permit system that a given emission level for participating sources is achieved incurs the cost of uncertain permit prices (and hence compliance costs). To address this concern, a hybrid policy that caps compliance costs could be adopted, but the level of emissions would no longer be guaranteed.

For a variety of reasons, in most countries the management of GHG emissions will not be addressed with a single policy instrument, but with a portfolio of instruments. In addition to one or more market-based policies, a portfolio might include standards and other regulations, VAs, and information programmes:

• Energy-efficiency standards have reduced energy use in a growing number of countries. Standards may also help develop the administrative infrastructure needed to implement market-based policies. The main disadvantage of standards is that they can be inefficient, but efficiency can be improved if the standard focuses on the desired results and leaves as much flexibility as possible in the choice of how to achieve the results.
• VAs may take a variety of forms. Proponents of VAs point to low transaction costs and consensus elements, while sceptics emphasize the risk of free riding, and the risk that the private sector will not pursue real emissions reduction in the absence of monitoring and enforcement.
• Imperfect information is widely recognized as a key market failure that can have significant effects on improved energy efficiency, and hence emissions. Information instruments include environmental labelling, energy audits, and industrial reporting requirements, and information campaigns are marketing elements in many energy efficiency programmes.

A growing literature demonstrates theoretically, and with numerical simulation models, that the economics of addressing GHG reduction targets with domestic policy instruments depends strongly on the choice of those instruments. The interaction of abatement costs with the existing tax structure and, more generally, with existing factor prices is important. Policies that generate revenues can be coupled with policy measures that improve the efficiency of the tax structure.

Turning to international policies and measures, the Kyoto Protocol defines three international policy instruments, the so-called Kyoto mechanisms: international emissions trading (IET), JI, and CDM.² Each of these international policy instruments provides opportunities for Annex I Parties³ to fulfil their commitments cost-effectively. IET essentially allows Annex I Parties to exchange part of their assigned amounts (AAs). IET implies that countries with high marginal abatement costs (MACs) may acquire emissions reductions from countries with low MACs. Similarly, JI allows Annex I Parties to exchange emissions reduction units among themselves on a project-by-project basis. Under the CDM, Annex I Parties receive Certified Emissions Reduction (CERs)–on a project-by-project basis–for reductions accomplished in non-Annex I countries.

Economic analyses indicate that the Kyoto mechanisms could reduce significantly the overall cost of meeting the Kyoto emissions limitation commitments. However, to achieve the potential cost savings requires the adoption of domestic policies that allow the use the mechanisms to meet their national emissions limitation obligations. If domestic policies limit the use of the Kyoto mechanisms, or international rules that govern the mechanisms limit their use, the cost savings may be reduced.

In the case of JI, host governments have incentives to ensure that emission reduction units are issued only for real emission reductions, assuming that they face strong penalties for non-compliance with national emissions limitation commitments. In the case of CDM, a process for independent certification of emission reductions is crucial, because host governments do not have emissions limitation commitments and hence may have less incentive to ensure that certified emission reductions are issued for real emission reductions only. The main difficulty in implementing project-based mechanisms, both JI and CDM, is to determine the net additional emissions reductions (or sink enhancement) achieved. Various other aspects of these Kyoto mechanisms await further decision making, including monitoring and verification procedures, financial additionality (assurance that CDM projects do not displace traditional development-assistance flows) and other additionalities, and possible means of standardizing methodologies for project baselines.

The extent to which developing country (non-Annex I) Parties effectively implement their commitments under the United Nations Framework Convention on Climate Change (UNFCCC; referred to as the Convention in this chapter) may depend on the effective implementation by developed country Parties of their commitments under the Convention related to the transfer of financial resources and technology. The transfer of environmentally sound technologies from developed to developing countries is now seen as a major element of global strategies to achieve sustainable development and climate stabilization.

Any international or domestic policy instrument can be effective only if accompanied by adequate systems of monitoring and enforcement. There is a linkage between compliance enforcement and the amount of international co-operation that will actually be sustained. Many multilateral environmental agreements address the need to co-ordinate restrictions on conduct taken in compliance with the obligations they impose and the expanding legal regime under the World Trade Organization (WTO) and General Agreement on Tariff and Trade (GATT) umbrella. Neither the UNFCCC nor the Kyoto Protocol provides for specific trade measures in response to non-compliance. But several domestic policies and measures that might be developed and implemented in conjunction with the Kyoto Protocol could conflict with WTO provisions. International differences in environmental regulation may have trade implications also.

One of the main concerns in environmental agreements (including the UNFCCC and the Kyoto Protocol) is with reaching wider participation. The literature on international environmental agreements predicts that participation will be incomplete, and so further incentives may be needed to increase participation.

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