Game Theory and Climate Change

Parkash Chander

• Publisher: Columbia University Press
• Year: 2018
• ISBN:
  9780231545594
• Topic: Mathématiques
• Subtopic: Théorie des jeux

Despite the growing consensus on the need for action to counteract climate change, complex economic and political forces have so far prevented international actors from making much headway toward resolving the problem. Most approaches to climate change are based in economics and environmental science; in this book, Parkash Chander argues that we can make further progress on the climate change impasse by considering a third approach—game theory.

Chander shows that a game-theoretic approach, which offers insight into the nature of interactions between sovereign countries behaving strategically and the kinds of outcomes such interactions produce, can illuminate how best to achieve international agreements in support of climate-change mitigation strategies. Game Theory and Climate Change develops a conceptual framework with which to analyze climate change as a strategic or dynamic game, bringing together cooperative and noncooperative game theory and providing practical analyses of international negotiations. Chander offers economic and game-theoretic interpretations of both the Kyoto Protocol and the Paris Agreement and argues that the Paris Agreement may succeed where the Kyoto Protocol failed. Finally, Chander discusses the policy recommendations his framework generates, including a global agreement to support development of cleaner technologies on a global scale.

1

PURPOSE AND SCOPE

Serious problems require serious policy responses, and no problem is more threatening to the human future than climate change, or global warming, caused by emissions of greenhouse gases (GHGs). Our understanding of the physical science of climate change has been growing steadily,¹ but there has been no meaningful progress toward fixing the economic and strategic forces that are causing it, except perhaps the Paris Agreement adopted by 196 countries in 2015 at Paris, France. This is often attributed to a failure of political will, but, as will be made clear in this book, it is the result of a particularly challenging economic and strategic setup. Accordingly, the book proposes game-theoretic solutions to the problem (which are efficient and immune to strategic behavior by sovereign nations) in the hope that it will lead to a better understanding of the economic and strategic forces behind climate change in general and of the Paris Agreement and its predecessor—the Kyoto Protocol—in particular.² It discusses why and how the Paris Agreement may succeed in controlling climate change whereas the Kyoto Protocol failed. However, applications of the theory developed in this book are not restricted to climate change alone. It is applicable also to other similar problems of global environmental externalities such as ozone layer depletion, acid rain, and sea and ocean pollution, to name a few.

1.1. THE MULTIDISCIPLINARY NATURE OF CLIMATE CHANGE

Climate change, which is caused mainly by emissions of GHGs, is a global environmental externality. It is an externality because it is a form of interaction between agents that takes place outside the market for exchange of goods and services, it is global because the externality extends beyond boundaries of any kind, and it is environmental because it affects people through the environment in which they live. Each one of these three characteristics of climate change puts it outside the scope of standard social sciences, especially standard economics. As a result, some basic concepts have to be modified and some new ones have to be invented to enable these sciences to cope with the issues involved.

1.1.1. The Three Disciplines

The choice of the title of this book puts game theory in the forefront because this discipline provides key intellectual tools to handle the problem. But more generally, three different disciplines are involved: ecological science, economics, and game theory. This section summarizes what the book has to offer regarding each one of them.

Ecological Science

Because the book deals with an ecological phenomenon, the reason for the involvement of this discipline should be obvious. Without pretense of contributing much new to this discipline, the book borrows from it whatever ideas are useful or relevant for the analysis. In particular, the main idea that is imported from this discipline is the concept of a transfer function, which is a tool whereby ecological science describes the effect of exogenous interventions on the measurable characteristics of the environment. How this tool operates is illustrated by an example of air pollution in chapter 2. In the rest of the book, only a simple linear form of the transfer function is used so that the complexity in this respect does not divert our attention away from the more important complexity of strategic interactions among the agents, which is the main focus.

Another idea that is borrowed from ecological science is the notion of a stock externality as distinct from a flow externality. Economics started to take note of this distinction only in the late 1980s when it could no longer ignore the ecological phenomena such as buildup of acidic depositions in soil due to acid rains or of accumulation of GHGs in the atmosphere due to their continual emissions on Earth. Before that time, externalities were treated just in terms of more or less bucolic examples of externalities, such as the celebrated bees and orchard fable and the locomotives that emit sparks and set fire to farmers’ fields.

The treatment of GHGs as a stock externality in the economic analysis forces introduction of time in the formulation of the climate change problem. One implication of this is the emitters and recipients of the externality may be separated in time in such a way that they cannot meet or interact (e.g., they may belong to different non-overlapping generations),³ making it impossible for them to engage in Coasian bargaining. Involvement of the government of each country, which can act on behalf of its future generations, is thus essential if climate change is indeed to be treated as a stock externality. Furthermore, ecological science also teaches us that phenomena such as climate change extend over a very long period. This has deep consequences for the choice of a discount rate that is appropriate for payoffs occurring only in a very distant future. Keeping these facts in view, chapters 7 and 8 treat climate change as a stock externality in contrast to its treatment as a flow externality in chapters 5 and 6.

At a more general level, introduction of economic reasoning in environmental matters definitely gives ecological science an anthropocentric perspective. That is so when economic analysis, whether positive or normative, is introduced in models in which human behavior affects a natural phenomenon. Indeed, a central concept in positive economics is that of an equilibrium, which is typically the outcome of utility or payoff maximization by agents representing the humans. This puts the natural phenomenon described by ecology as an object that is subject to human behavior and gives it essentially a human perspective. This is a fortiori so with normative economics, in which human behavior with respect to nature is advocated on the basis of criteria chosen and formulated by humans or agents representing them.

Moving one step higher in this philosophical discussion makes one realize that the anthropocentric view is the source, and the only source, of attributing value to environment.⁴ Indeed, the notion of value itself is void if not supported by humans. As a natural corollary, the notion of pollution rights may be interpreted as an export from economics to ecological science. Because natural resources have value, they must have prices that are meaningful in a market economy. Moreover, prices mean exchange, and exchange presupposes property rights. In this way, the notion of pollution rights appears to be an export from economics to ecological science.

The theory developed in this book eventually leads to a fairly fundamental rethinking of the notion of value of environment, which is a matter of debate between “environmental economics” and “ecological economics.”⁵ Chapter 8 revisits this issue. It proposes a value that is free from the typical notion of scarcity in economics and from the exclusively physical thermodynamic theory of energy relied on in ecological economics. It is derived from a dynamic model in which each country is assumed to have developed so much that the capacity to produce consumption goods, whose production results in GHGs emissions and climate change, is no longer a binding constraint. Instead, the environment is the only limiting factor, and all countries have equal opportunity to exploit it. The countries differ, if at all, only in terms of how they are affected by their own emissions and climate change. Consideration and analysis of such an idealized world model leads to a reconciliation of the two different views regarding the value of environment, as then it is optimal to minimize the polluting energy content of delivered goods and services. The analysis also leads to a proposal that can serve as a reference in the negotiations on climate change. Roughly speaking, the proposal means that a country affected relatively more by its own emissions and climate change should have fewer rights to emit GHGs that cause local pollution and climate change.⁶ Such a proposal is free from any normative considerations such as equal per capita emission rights or grandfathering of current national emissions, but, as discussed in chapter 9, it may be considered unfair by some countries, especially by the low-lying island states and least developed small countries, which are affected by climate change but contribute little to it.

Economics

As to economics, known to be the science of resource allocation, the first extensions and novelties, introduced in chapter 2, are at the basic level of making precise whether and how the environment can be treated as an economic good. Connections are established between the standard notions of externalities, private goods, and public goods. In fact, all three are involved, and disentangling their respective roles in the climate change problem is a necessary starting point.

With this in mind, the basic framework for this work is presented in chapter 3 in terms of the two main classical strands of economic theory; namely, general equilibrium, a positive one, and welfare economics, a normative one. In both cases, the fact that the agents are sovereign nation-states is kept in mind, as this is the single most important fact underlying the climate change problem that distinguishes it from a standard externality problem. The proposed framework is also in the spirit of public economics, which recognizes the role of government in a market economy when widespread externalities are involved.

In 1960, Ronald Coase introduced a very powerful idea of great importance, and this idea has had arguably the single most important influence on policy for the problem of externalities in the past five decades. He argued that in the absence of any transaction costs, assignment of arbitrary but well-defined pollution rights and bargaining among the parties involved can internalize any externality and ensure efficiency. This was later dubbed “the Coase theorem.” However, Coase took for granted the existence of a government or authority that can allocate and enforce pollution rights between the parties involved. He did not foresee the global problem of climate change where there is no such authority at the supranational level. Thus, the Coase theorem as such cannot be applied to the externality problem of climate change.⁷ Furthermore, Coase did not consider stock externalities, which as noted above can make Coasian bargaining impossible among the current and future affected parties.

Chapters 5 and 8 propose suitable generalizations of the Coase theorem that are applicable in such instances of externalities that were originally ignored by Coase (1960). Chapter 5 treats greenhouse gases as a flow externality and shows that in the absence of a supranational authority, the nation-states will themselves assign rights to each other that are self-enforcing in the sense that none of the nation-states will have incentive to violate them. Furthermore, as the original Coase theorem predicts, such self-enforcing rights can lead to efficiency if they can be traded on a competitive market. However, unlike the assertion of the original Coase theorem, not every arbitrary assignment of rights can lead to efficiency, as every assignment of rights is not self-enforcing. Similarly, in the dynamic model in chapter 8, which, unlike chapter 5, treats GHGs as a stock externality, the steady-state Nash equilibrium emissions are interpreted as self-enforcing pollution rights that can lead to efficiency.

For the same reason for which the Coase theorem does not apply to climate change, the Pigouvian argument (Pigou 1920) that appropriate taxes and subsidies can internalize externalities cannot be applied either. Thus, in the absence of a supranational authority, only voluntary negotiations and agreements among the sovereign countries can ensure efficiency, if at all. What should be those negotiations and agreements, and what should they bear on? That is broadly the theme pursued in this book.

Climate change has the characteristics of a global public good (or rather a bad). However, it does not fit the conventional notion of a public good. That is because reduction of greenhouse gas emissions by a country can be more than offset by another country, which may respond by increasing its own emissions. By contrast, in the conventional model of a public good, contributions to the public good by an agent cannot be neutralized by other agents. An agent can at most not contribute anything to the public good; it cannot reduce the public good provision made by others. Thus, the incentive to free ride in the case of climate change is much stronger than in a conventional public good model.⁸ Dealing with it requires concepts and solutions that are more appropriate for tackling climate change, which, as noted above, provides stronger incentives to free ride. These are discussed later in the subsection on game theory.

Disentangling the private and public good aspects of climate change is an important step in understanding the virtues of the “cap-and-trade” mechanism, which was proposed in the Kyoto Protocol and has been retained in the Paris Agreement. In summary, the argument presented in chapters 5 and 9 is as follows: Decisions pertaining to “caps” are, in the aggregate, decisions on the provision of a public good, which explains and justifies that they be decided and agreed upon by the governments of the nation-states when negotiating an aggregate emission target. By contrast, decisions to “trade” in emissions pertain to private goods, namely, the pollution permits, and this explains and justifies that they be left to markets. The economic analysis in chapters 5 and 9 shows that these two types of decision-making processes are complementary to each other and together form a mechanism that can lead to a solution of the climate change problem.

Beside negotiations on climate change, countries are also currently engaged in negotiations on trade liberalization through the World Trade Organization (WTO). Though the negotiations on these two international problems have been conducted independently of each ot...