The participation of developing countries and EITs in the UNFCCC is important, since these countries are both large future emitters of carbon, and sources and potential sources of low-cost abatement investments (McKibbin and Wilcoxen, 2000). Since the participation of regions with low marginal abatement costs may be critical for aggregate cost and emissions reduction, encouraging their participation may require a serious consideration of the equity implication of that policy (Morrisette and Plantinga, 1991). Unlike efficiency, there is no universal consensus definition of equity by which policy instruments can be evaluated. Recent research on equity, however, analyzed the welfare impacts of climate policy alternatives to understand the participation incentives (for different countries and regions) of various policy instruments (Bohm and Larsen, 1994; Edmonds et al., 1995; Rose et al., 1998).

The types and structures of mechanisms adopted (such as uniform taxes, tradable quota, or individual non-tradable targets) affect the scope and timing of participation in some predictable ways (Edmonds et al., 1995). For example, individual non-tradable targets based on the stabilization of national emissions would shift more than 80% of aggregate costs to non-OECD regions by 2020, making it unlikely that these regions would participate in such an agreement (Edmonds et al., 1995).

Alternatively, with a common global carbon tax and full participation, the burden of abatement costs would be distributed unevenly across the world and would change with time. A large burden would fall on OECD and economies in transition in the early years, shifting to developing nations in later years (Edmonds et al., 1995). Transition economies would thus be unlikely to participate in a common global carbon tax agreement. If such nations were to participate in the short run, growth and changing economic and political circumstances may increase the probability of their dropping out of a tax agreement when they face increasing net participation costs (Edmonds et al., 1995).

The equity implications of a global tradable quota system depend on quota allocation. The portion of global abatement costs borne by a country or group of countries depends on its relative position in the quota market; net sellers of quota effectively receive income transfers from net buyers. Table 6.3 describes the relative position of groups of countries in an international quota market, based on six possible initial allocations (Edmonds et al., 1995).¹⁰²

Of course, a country’s participation in an allocation scheme depends on net costs (the sum of transfer payments associated with quota trade, plus direct mitigation costs), not just the direction of income transfers. However, that the direction of transfers may change over time, especially for China and the transition economies, complicates the incorporation of equity goals in quota system design (Edmonds et al., 1995). Although quota allocation is referred to here, the analysis applies equivalently to redistributing international carbon tax revenues (Pezzey, 1992; Rose et al., 1998).

Bohm and Larsen (1994) explore the participation implications of two of the more frequently discussed of the allocation schemes listed in Table 6.3 (allocation by population and by GDP) for a quota regime covering Western Europe and Eastern Europe. Both of these allocations, and combinations thereof, lead to substantial losses by the Eastern European countries, making their participation unlikely (Bohm and Larsen, 1994). Given the aggregate cost-savings associated with their participation, an ideal allocation system would provide the minimum possible participation incentive to the Eastern European countries, while maximizing potential abatement cost savings to the western countries. The authors identify this lower bound in terms of eastern country quota-to-emissions ratios that would induce participation, ranging among countries from 0.85 to 0.91. This incentive scenario results in zero net gains (losses) to the eastern countries, and net costs to each western country of 0.09% of GDP. In the presence of wide disparity in current regional economic welfare, the perceived equity benefits of such a scenario may facilitate a more cost-effective agreement than any that might be achieved without Eastern European participation.¹⁰³

If quota allocations are used to induce participation by transition economies and developing countries, the international wealth transfers that occur as a result may cause fluctuations in real exchange rates and international capital and trade flows (McKibbin and Wilcoxen, 1997a, 1997b). The magnitude of these fluctuations and the extent to which they could be problematic are uncertain. McKibbin and Wilcoxen (2000) suggest an alternative approach to the problem of equity versus participation incentive, which includes both short-run emissions quota and long-run emissions “endowments”. In this approach, the price of emissions quota is set through international negotiation at regular intervals (they suggest every decade), and each country issues as many quotas as necessary to keep the price at the negotiated level. The price of emissions endowments, however, is flexible, and the quantity allowed per country is fixed. Each participating country’s endowment prices reflect expected future prices of emissions quota.

Table 6.3: Direction of income transfers in international emissions trading, six possible quota allocation schemes
Anticipated position of participating countries, 2005-2095
Tradable quota allocation	OECD countries	EITs	China and other centrally-planned Asian countries	Rest of world
Grandfathering	Net sellers	Net sellers	Net buyers	Net buyers
Equal per-capita emissions	Net buyers	Net buyers	Net sellers early, Net buyers post-2035
GDP-weighted emissions	Net sellers	Net effect small and ambiguous	Net buyers	Net effect small and ambiguous
GDP-adjusted grandfathering	Net buyers	Net sellers	Net effect small and ambiguous	Net effect small and ambiguous
No harm to developing nations	Net buyers	Net sellers early, net buyers post-2035	Net sellers	Net sellers
No harm to non-OECD nations	Net buyers	Net sellers early, net buyers post-2035	Net sellers	Net sellers
Source: Edmonds et al. (1995). Notes: Under GDP-adjusted grandfathering, emissions rights have a baseline at current levels, adjusted for income growth. The “no harm” scenarios allocate sufficient quota to the relevant countries to cover their own emissions and to generate enough revenue to cover economic costs of protocol participation.

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