The International Emissions Trading Association (IETA) is as old, I guess, as carbon emissions trading. We came out of the United Nations Environment Programme (UNEP), the United Nations Development Programme (UNDP), and the far-sighted approach of some energy companies; particularly Canadian and British ones, at the end of the last century. It is now quite a substantial organization which is unique in combining membership from major emitters; in particular power companies and other energy-intensive companies, and the sort of companies associated in the public mind now with emissions trading, providers of financial services, and those who assist with the identification and development of emissions-reduction projects across the world.

The three areas that I want to talk about then which are of great importance for IETA as well for the development of emissions trading throughout the world are: the current situation of the EU emissions trading scheme, the third phase which is being designed at the moment by the institutions of European government; the emerging U.S. national schemes, I used plural for reasons that will become clear as I go through the talk; and the sentiment of the carbon market - it is fair to say that the carbon market has developed into an entity where the way that they feel about the future actually has the capacity to influence the future, if not define it.

To start with the European Union Emissions Trading System (EU-ETS): what are the key elements of the package that the European Commission has put on the table to take forward and build on the lessons of the first two phases of the EU-ETS? Most importantly the EU-ETS is seen as a very significant part of the pathway that the European governments are setting out toward a 20% or 30% emissions reduction by 2020. You probably know the reason for that alternative is that if there is a satisfactory international agreement, there will be a reduction by up to 30% by the EU. If there is no international agreement then the European government is committed to making a 20% reduction, thereby providing quite a substantial flaw, if you like, of demand, though perhaps, as we shall see, not sufficient for the needs of the market at the moment.

The coverage of the emissions-trading scheme in Europe is being extended: a combination of some sectors and sub-sectors and some gases other than carbon dioxide (CO2). But at the same time the coverage is being tidied up with the possibility of opting out for the very small installations. The experience of Europe in having 15 different caps and trying to ensure harmonization between them was not a happy one. Even the most harmonization-phobic of European countries has now agreed that we should move toward a single European cap and the direction of that cap over the years through to 2020 is clearly set out: a linear decrease year by year.

Allocation systems are to be harmonized, taking into account cost pass-through, which is the ability of companies to physically make their customers pay at least part of the additional costs that they incur, and carbon leakage, which is the current term for the escape of carbon-intensive industries away from Kyotoland and into non-Kyotoland, a very substantial concentration on auctioning, and an early recognition of the huge amount of income that could come from auctioning; 30-60 billion euros a year. The suggestion is that some of that should go toward climate-change purposes.

The package is very strongly based on quite comprehensive economic analysis. And the analysis is that the gross domestic product (GDP) impact will be as little as 0.35% in Europe in 2020. The path toward linking systems would be made easier. There are, at the same time, other harmonization proposals and many other proposals on the table about energy sources.

What are the chances of all that getting through the political process which it now has to undergo? There is political worry that the expansion of the market is merely an expansion in speculation and that this is another market, after the sub-prime mortgage market, which is capable of going wrong and pulling down economic progress with it. Many members of the European Parliament and other politically influentially people have favorites among low-carbon-energy technologies, and the current proposal is that there should be a special weighting of emissions-reduction tons that come from carbon capture and sequestration (CCS): that it should count for double the emissions reductions from any other means. Many people regard that as a strange way of dealing with the idea of carbon as a commodity, where a ton is a ton is a ton, but the pressures are nevertheless very strong.

Many say there should be coverage of transport. Exactly how, beyond what has already been done regarding aviation, is unclear. Carbon leakage I mentioned before, but reference to the coverage of that subject in international negotiations is a politically hot potato, and so is the threat of border adjustments. In other words, making sure that imports into the EU of goods and services from countries with a major energy input, a major carbon input, but one that is not provided for in those countries' own domestic regimes, has become a serious matter for certain countries and it looks set to absorb the interest of many European members of parliament. Some member states have special circumstances that get in the way of economic rationality. That applies to most of the eastern European countries that have a phobia about finding themselves dependant on Russian gas.

But probably the biggest political problem area is managing to have all these problems resolved and coming out with a conclusion by December 2008. The reason for that timetable is that if it slips beyond the end of the French presidency, firstly it could enter the Czech presidency, and the Czechs are less interested perhaps in climate change and emissions trading than others. But we also get dangerously near the point where the pre-election mood sets in on the parliament, and a new set of parliamentary members, then a new set of commissioners will be elected. This is particularly difficult for a dossier as complicated as this and particularly difficult for the many different European parliamentary committees to come together and negotiate in the way that the directorates of the Commission have had to negotiate. Doing all this by the end of the year is serious business.

Let us take a look now at the competitiveness issue as being possibly the biggest problem. I call it a puzzle because many analysts, looking across the whole European economy, see very few sectors where an increased energy costs would significantly affect competitiveness of European firms in comparison to non-European firms. There is a lot of study on this but the purpose of the diagrams you see is to show that at least for a couple of those sectors, while the total contribution to the European economy of those two sectors may be comparatively small, at the level of 45 euros per ton of CO2 price, a very clear model can be drawn on the likely outcome on the basis of profit-maximizing behavior by the companies concerned, and expected elasticities of demand. There is a major drop in EU production and an almost corresponding increase in imports, and therefore leakage of CO2 outside the EU is assumed. As I said, this is at the level of 45 euros per ton; not fanciful by any means. Already the price is 25 euros and currently increasing by the week. So, you can see that there is maybe for only for a few sectors but it's a real problem.

What can be done? This is a diagram just recently produced by my friend Dr. Michael Grubb (Faculty of Economics, University of Cambridge) on carbon strategies to conceptualize the various things that could be done to try to redress the balance. On the left you see what happens if there is no mechanism. Inside the EU-ETS up goes the cost - the blue extension of the white line. Outside the EU-ETS the price remains the same. What actually happens is the arrowed middle column. It is a question of the balance of profit maximization behavior or strategic protection of markets which determines what exactly companies will do. What can governments do about it? They could reallocate, recycle the revenue they receive from the additional cost, assuming they take it in the form of auctioning, which as we have seen is the lead alternative in Europe. Of course, one of the problems is there is then little substitution toward low-carbon products and services. In other words, the whole purpose, which is to put a price on carbon, is affected adversely by simply handing back the money so that if there is a price on carbon it is simply not felt. That distorts investment if we are looking for low-carbon investment in the future, and it may constrain innovation as well.

If we look at the next figure, border adjustments, this is a fiscal or customs means of adjusting the balance, but of course the difficulties with that are clear: immediate potential problems with the World Trade Organization (WTO) and with bilateral trade relations, even if there is a way through the WTO. This really requires at least some form of informal international cooperation.

The ideal is the third of the alternatives: globalizing the carbon costs and the search for full-cost sectoral agreements whereby in these competitive areas outside the EU-ETS, companies agree to increase their own costs by a comparable cost of carbon. This would be wonderful if it could be achieved. It is the hope of many who look at sectoral agreements that this is what could come out of it. But it does require a very different attitude by developing countries than that we have seen so far. And it also risks the CO2 price being set perhaps by the lowest common denominator. Identifying the appropriate increase would be no simple matter.

But on the whole, the verdict of our members, that is to say from the trading organization's perspective, this is a very good package by the European Commission. It has provided some necessary operational improvements on the last phase and tidied up a number of the issues which have led to problems. There will be, as they say, some devil in the detail after the legislation as to exactly how things are done and the levels of certain parameters. But look at what is now on the table: textbook forms of assistance to trading and what trading can do in, most importantly, a much longer period in which price can be visible and can particularly signal to investors, and give a clear direction of travel. The speed with which the cap is expected to tighten is made clear and that is indicated to continue beyond 2020 as well.

It is very good that the principle of auctioning has been taken as the lead approach. There is nothing better even though this requires a certain amount of care. We have harmonized cap and allocation methodologies instead of the previous bewildering complexity and scope for cries of unfairness. The way the Commission has behaved with the phase two caps indicates a real determination to avoid a situation of inadequate demand, which is one interpretation of what happened in phase one. Definitions, harmonized proposals for linkages, are still there and there is some expansion as well.

Let us look in more detail at how the credibility of the EU-ETS was damaged, particularly in the U.S., and see what has been done to improve on that. The phase one price crash which is visible as the wriggly line crashing to the bottom from October 2006 did enormous damage to Europe's system, even though we protested very strongly that this was very much a trial-run system. Auctioning on its own should help to keep the markets stable. But it is becoming very clear that some of the arguments are that there was merely over-allocation and a craven giving in to industry demands. Some of that argument is now being rethought as research is beginning to show that 2005 and 2006 emissions were lower than the baseline projections by up to 5%. This is a reasonable assumption though impossible to prove that at least when the prices were high, active actions were taken which actually reduced emissions, and that is what the whole thing is supposed to be about. The price is now sustained in phase two, as we can see, and the emissions reduction there is quite substantial. We need this tradability not to just hold up Europe's head in the world but to provide those sustained price signals which are necessary in order to move the effect of the EU-ETS from fuel-switching into new investment.

Some confusions do remain and the one that worries IETA most is that the cost reductions which can be achieved by investing in emissions reductions projects outside the Organisation for Economic Co-operation and Development (OECD). The figure taken from Climate Change 2007: Synthesis report by the Intergovernmental Panel on Climate Change (IPCC) shows the higher part of the bar charts being the scope for emissions reductions at various prices by sector in the non-OECD world. That is being put at risk by the Commission's unwillingness to let CDM into the phase three equations.

Perhaps the largest question however is one that every government has to worry about: an unresolved confusion with renewables support policy. What approach will actually ensure that the market takes over after support from the government brings the average per-unit cost of new technologies down to a level consistent with a reasonable market price? Renewable targets without new mandatory policies look highly uncertain and could actually lead to taking the market's choice for it. And if sufficient emissions reductions are mandated then there is no role for the market to help companies make the right choice using the power of the market.

I'll provide a very brief coda of what is happening in the UK. Two important advances which were revolutionary when they started are now being caught up to, not the least by some of the work going on in Japan. The UK has a carbon-reduction commitment which is an extension of the principle of trading well beyond the energy-intensive area and into larger commercial and public sector organizations. We also have in the UK an independent committee with responsibility for reporting to parliament; really the unprecedented power of deciding whether the government's proposals for emissions reductions are consistent with its overall objectives and its 2050 target. This is a way of ensuring that politicians cannot just hand on the problem and targets to the next generation, and the generation after that.

Let me move to the U.S. Mr. Obama is not actually saying a great deal but it is a commitment to market-based cap and trade with a commitment to 100% auctioning. And as is typical for the U.S. and indeed also for Europe, there is a great deal of consideration on what to do with the money then acquired.

Mr. McCain has come up with a rather more substantive set of proposals and some of the features here are certainly worthy of thought, particularly to any country thinking that there will ultimately be a global system which includes the U.S. The progress toward auctioning is potentially quite slow. There is a perhaps superfluity of new organizations; a climate change credit operation and a commission to decide on how some of the benefit is distributed. There are unlimited initial offsets from domestic and international sources. That may get changed but that seems to be what we are talking about at the moment. And there is a strategic carbon reserve which is a means of getting over hard times or high prices and the border adjustments are beginning to feature very clearly there as well.

In Congress, really the only area to concentrate on is the Lieberman-Warner bill. Note that there are now up to 15% domestic offsets; 5% international project-based credits (they do not use the term CDM); and another 10% of international forest-protection credits. There is a great deal of political weight being given to market oversight to prevent speculation and manipulation, and a great deal of emphasis being given to using some of the income for what is described as transitional relief and partnership.

What is the prospect for Lieberman-Warner and thereafter? Well these are inauspicious times, with the concentration on the rising gas price, to be introducing a stringent bill on climate change. There is still some uncertainty about exactly when the bill will get on the floor, whether at the beginning of June, later in June, or possibly not even at all. After that when we talk about a new president the timetable here is what Senate staffers of long experience were telling the IETA at Carbon Expo in May 2008 in Cologne. And you will see that we will be able to reach the target by 2014 without too much difficulty and Republican staffers say even that is very optimistic. And in the meantime there are lots of bear traps; most recently the opportunity for environmentalists to use the Endangered Species Act as a means of suing just about everybody who emits carbon dioxide. Our concerns in the U.S. are about the fundamental misunderstanding that is still there in the political circles of cap and trade. Price caps and safety valves keep on being bandied about and there is a fundamental mistrust of any offsets or anything which is really not made in the United States of America.

My third and final area to address is the state and sentiment of the carbon market. Regarding this topic, there is a very good recent paper by the World Bank called the "State and Trends of the Carbon Market 2008." I would just like to give a reminder of how immensely quickly this market has grown from these figures from one of the major investment analysts in the area: it is now at 67 billion dollars, which is pretty small still compared with currency markets say but this is the sort of level that makes most financial institutions begin to sit up and take notice. And the way that the market is moving toward more exchange-traded products and increasing different types of products, including derivatives, suggests that the market is going to continue a fairly rapid increase. There is one further point to be made that was raised in the World Bank's paper. The rapidity and size of the growth of CDM investment in clean energy is underappreciated. It is not all about hydrofluorocarbons and it is clearly a case where a good price for carbon emissions reduction is capable of leveraging significant investment in clean energy.

Now, looking at sentiment; maybe that graph that I showed you before or those increasing bars will reduce a little bit because although all participants are confident that the market will continue post-2012, there are fewer who think that it will become a better business proposition. Perhaps there are signs of peaking but the market is still expecting significantly higher prices beyond 2012. The assumption is that we will find some way of getting over the hurdle of the international negotiations. Unfortunately we did not ask about prices over 35 euros. Perhaps we should have, but I think some people are talking 40 euros or even 50 euros. And that also applies to the prices of the CDM units as well, despite the blow that the EU or the Commission given to the immediate market after 2012 in the event of no international agreement. So, whatever the negotiations may think about the depth of the trenches they are in, it is good to know that the market believes that they will get out of them somehow.

Very briefly then, I will present my findings. What happens if there is not an international agreement in place in 2013? Is it necessary to deciding everything by 2009 in order to ratify the agreement by 2012? What is the true scope for linking, despite all that is said, when levels of ambition for 2020 still seem to be so different? And then the point that I have made before: is it possible that the project market could actually be destroyed for maybe a generation of investment by the EU's negotiating ploy?

And here, again for some discussion, are issues with Japan. When is it reasonable to expect that Japan's industrial competitors will be adequately covered by an international regime? Is the idea of an international sectoral approach actually going to produce any dividend which will benefit or reassure Japanese industry? Is there actually any difference between the hard voluntary scheme of the type that in some places we have here in Japan and the formal cap and trade scheme which everybody says must be legally based and not voluntary. If there is a difference is that in and of itself going to be enough to prevent linking? And how much does that really matter?

Finally, an advert, if you do not get the answers to your questions here today, here is a place where I hope you will be able to go and get those answers: the Carbon Forum, Singapore, Nov. 12-13, 2008. Thank you very much.

Comments:
Mitsutsune Yamaguchi

Before I start my speech, one point I wish Mr. Derwent to know is the Japanese feeling about the Kyoto Protocol. Most Japanese feel we suffer the most because of the Kyoto target. And actually the IPCC Assessment Report shows that marginal abatement costs to implement the target in Japan are the highest, followed by Europe and the U.S. Also as a member of the Japanese government committee on how to implement the Kyoto target itself, I can say that we found this is very hard for us to do, unlike it was for the UK. And you may be surprised to know that, in addition to the Japanese government announcement to purchase carbon credits of 100 million tons (over five years) from the Hungarian government, private companies, especially power generators and iron and steel companies, have to purchase more than twice what the Japanese government would purchase from the overseas market. So for them CDM is a term they do not wish to hear. This is, in a sense, the prevailing feeling.

About cap and trade; those arguing for it are mostly from the financial sector. So, that raises some kind of suspicion among manufacturers, which feel the financial sector is arguing for its own profit. Having said that, I would like to make my very brief presentation.

First of all, I do not think it is a good start to discuss whether cap and trade is good or not. First, we have to discuss the issue of scarce resource allocation. Everybody knows the Millennium Development Goals which were agreed on in the year 2000 at the United Nations Millennium Summit. There are eight major issues for which global cooperation is definitely necessary: poverty, hunger, HIV/AIDS, malaria, or primary education, etc. And there is environmental sustainability, one of eight very important global issues. So, how should we allocate scarce resources to those issues? If we use, for example, 30% of our resources for climate change, this means we cannot use those resources for the other remaining seven.

So, how do we allocate our money? This is the area which especially the global leaders have to discuss. Climate change is of course one of the fields included in environmental sustainability. I, as a researcher, have been involved in this for around 20 years, so I think I know how important the climate change issue is. But this is not the sole area which is important; of course the energy security issue is important too. So, with renewable energy we have some kind of synergy effect. But when it comes to energy security we have to rely on coal: this is quite against climate change. Everything has to be taken into consideration.

What is important in climate change? In other words, what is the ultimate objective to cope with climate change? According to Article 2 of the United Nations Framework Convention on Climate Change (UNFCCC), the ultimate objective is stabilization of greenhouse gas concentration at a level that would prevent dangerous anthropogenic interference with the climate system. However, at this moment no global agreement has been reached on the level. The EU's idea is to limit temperature increase within two degrees since the start of industrialization. To achieve this target, the concentration level should be around 350 ppm CO2, but our research shows that stabilization at 550 ppm CO2 is acceptable. We first have to discuss our common objectives and agree on a certain level. At the moment there is no such discussion outside the EU.

Then if we can agree for this ultimate objective, then the next thing we have to do is set a long-term target, such as toward 2050 or 2100. At this moment the EU insists on 50% emissions reduction globally since 1990. That is quite in line with the EU's two-degree target. However, when our prime minister says a 50% reduction in 2050 from current level, what is that for? We do not know because we do not have any of our own ultimate objectives. This is a legitimate issue for Japan. If we have some kind of global long-term target, then of course we can have medium-term targets. We have to agree on medium- and long-term targets. Of course 50 years from now we do not know what is going to happen. So, it is non-binding, but for the mid-term, post-Kyoto target, it should be kind of binding. I do not think a Kyoto-like target will be accepted but in any case each country has to be responsible for its own target. And of course this must include major emitters such as the U.S. and China, India, and Brazil. This is a definite condition.

So then, what Japan can do? Without knowing the extent of reduction and its cost how can we discuss a global framework? That is what is completely lacking in our discussions which I wish everybody would realize.

Now we come to Japanese domestic policy after 2012. I have three very important points that we have bear in mind in mapping out our strategy. The first one is that there will not be any possibility to continue a Kyoto-like international framework that includes the U.S., China, and India. Of course this is ideal if they can agree; international cap and trade is the best. But I do not think there is any possibility that China and India can join from 2013. We must find an alternative way to invite them because we definitely need them to join us. The question is how. This is my first point.

My second point is regarding catastrophe. Climate change will cause gradual damage, but what really matters is so-called abrupt change, such as the shutdown of thermohaline circulation (THC). That will make the UK, for example, 10 degrees lower than the current temperature. And there is the possible collapse of Greenland or the west Antarctica ice sheets which could result in more than 10 meters of sea level increase. Those are the real catastrophes. However, according to Fourth Assessment Report (AR4) - and I was involved in both the Third and Fourth Assessment Reports as one of the lead authors - at least in the coming 100 years such catastrophes are unlikely even if we continue the current economic activity. Of course this does not mean these catastrophes will never happen. They may, but not within 100 years. That means no threshold for greenhouse gas concentration. This may lead to the conclusion, at least for the coming 100 years, that we do not need to introduce very stringent policies forcing us to never exceed a certain concentration level. Even if we may overshoot a limit, we may be able to return to previous levels later on.

The third point is a technology issue. Technology is the real key when we evaluate our domestic or international policy. Environmental effectiveness, cost effectiveness, equity, or political and administrative feasibility are the criteria which the IPCC report notes in Chapter 13. However, I will add another criterion on whether a policy promotes technology innovation and diffusion. The following is the simplest form of "Kaya identity." CO2 emissions here equal CO2 emissions divided by GDP/multiplied by GDP. Then we differentiate the equation.

In the left-hand side of the equation, ΔCO2 divided by CO2 is the change of CO2. The first item in the right-hand side of the equation is a change of the amount of CO2 emitted per unit of GDP. I call this technology change or technology improvement ratio. This includes both energy efficiency improvement and fuel-switching. If a power plant switches its fuel from coal to gas or nuclear, those aspects are all included. ΔGDP divided by GDP shows the change of the GDP growth ration. The above equation shows that if we need to reduce CO2 emissions, we can do it either by enhancing the technology improvement ratio or by reducing GDP growth ratio (or by both). This is very simple mathematics.

I made a very simple calculation. In the past 35 years for which we have global data, the average yearly technology improvement ratio is 1.227%. If we continue to improve our technology by 1.227% but still wish to reduce CO2 emission, for example by half in 2050, then what will happen? Global GDP loss will be 80% from business as usual (BAU). This will never happen. Politicians can never force this kind of policy on us. And then if the politicians do not wish for GDP to decline, so that at least it grows by way of BAU, but they also wish for CO2 emission to be reduced by 50%, then what is the technology improvement rate ratio? It is 3.856% per year on average. This is more than three times the past 35 years' technology improvement ratio. We have never experienced such a high technology improvement ratio, and we have to continue annually for the coming 50 years. So, definitely without technology improvement, if we just cap then that means reduction of GDP.

So, I would like to support our government policy that is called the "sectoral approach." This is intensely targeted for each sector. Of course this covers not only the manufacturing and energy sectors but it also covers construction, transportation, and electrical appliances, for which we have experience in Japan. And of course the target itself should definitely be a global top-runner. This energy intensity target is the best way to promote technological development, diffusion. There are two aspects to promote technology innovation/diffusion; demand pull and technology push. The sectoral approach is in the field of demand pull. On the technology push side, we also have to focus on government R&D. The Japanese government recently decided to focus on 21 innovative technologies. According to an estimate by a Japanese think tank potential global reduction in 2020 by introducing a global top-runner approach is about 6 gigatons CO2, which is around a 30% reduction from 23 GtCO2 of the current global emissions.

About cap and trade; what matters is the cap itself. Trade is alright but the question is whether or not we can cap the economy, and whether or not that cap can reduce emissions. If we have a drastic cap without technology improvement, we will just end up with GDP loss. Jeffrey Sachs (Director, The Earth Institute at Columbia University) supports this claim. Nigel Lawson, the Chancellor of the Exchequer under the Thatcher government and wrote that a cap is a kind of government-controlled administrative rationing system. His concern is also regarding the cap itself and allocating Soviet-style production permits wherein only the middlemen can earn money.

Mr. Derwent probably has plenty to say against this. Because of time constraints, I did not quote Lawrence Summers, the former U.S. Secretary of the Treasury and former president of Harvard University; he says almost the same thing. Also Alan Greenspan in his recent book, after he resigned as Federal Reserve Chairman, says almost the same thing.

Another point is that we really must thank the EU for its spectacular experience, or experiment. We are eagerly watching its progress. Actually I was in Europe and the U.S. last month as a co-leader of Japanese Government Research Delegation. We were able to make many observations on the state of cap and trade in Europe and the U.S.; of course both pros and cons. We really thank the EU. We do not just imitate what the EU is doing; we can see the good points we must import and the bad points we do not.

It is noteworthy to realize the basic difference between the U.S. and Japan: this is very important. For example the EU failed to introduce common energy/carbon tax in the early-1990s. Because each country has its own sovereignty and no consensus was reached. I heard that the UK and Spain were against taxing. And tax in the U.S. is very unpopular and hard to implement. Against this backdrop, cap and trade has been introduced in the EU and is being considered in the U.S.

There is also the issue of voluntary initiative. For example in Japan, as Mr. Derwent told us, we have an industry voluntary initiative in which there is no penalty. The target is set to stabilize CO2 emissions by 2010 at the 1990 level. So far it is doing very well. It seems unlikely the initiative will work well without penalty from the western viewpoint where all actors pursue short-term profit maximization. This reflects cultural difference.

It is my impression through a recent trip to the EU that the purpose of the EU ETS is to continue it by stabilizing the emission permit price. Without a stable price, it is very hard for manufacturers to invest in innovation to reduce CO2 emissions. This may lead to the collapse of the cap and trade scheme. However, for cap and trade to be efficient, price should fluctuate, because the economy fluctuates. So, dealing with this is very difficult and we should learn from the EU's experience.

And regarding the French presidency of the EU, as Mr. Derwent just mentioned, the French environmental ministry told us four areas it will address. One is auction itself, second is a use of auction revenue, third is restriction of CDM which Mr. Derwent already mentioned, and fourth is the competitiveness issue. Leakage is also a big concern but there is not enough time for me to address that. One point is linkage with the U.S. We visited the government of the state of Massachusetts and found that it is difficult for both EU and RGGI (state-led cap and trade scheme in the northeast U.S.) to link because permit prices are so different and the state government has no authority to conclude treaties with other governments. As for a federal plan, such as the proposed Lieberman/Warner Bill that includes economy-wide cap and trade, we have to wait and see what will happen at this stage.

Henry Derwent

I will make just a couple of points which I think Professor Yamaguchi has heard before on a couple of the issues that he concentrated on. The first is that there is probably enough parity regarding a long-term target for the argument effectively to be over. As soon as a number of G8 countries started talking about at least 50% by 2050 and as soon as some of the Bali decisions were populated with some numbers from the IPPC, the fact that the international regime saw a broad pathway, I think was pretty clear. Frankly, it does not make any difference whether you choose minus-50% or minus-70% or even minus-80% for 2050, in terms of what you do over the next 10 years. And that is, I think, in terms of politics, what we are concentrating on. To be uncertain whether you will do nothing or allow an 18% increase or whatever does make a difference to action taken over the next 10 years. If everybody is saying roughly the same thing, then that is probably enough for us to say, "Okay, we do not need to clarify the argument much more than that."

My second point is the question of whether we need technology to achieve the reduction of emissions. Of course, we do. Of course our way out of this mess is only going to be through technology. And I agree entirely with his point that the most important criterion for domestic and global climate policy is whether it promotes the development of that new technology and its diffusion. Here I think we part company because I cannot conceive of any means which does not involve a price signal to the private sector to achieving the size of development task and the breadth of diffusion task that is required. If you take the International Energy Agency (IEA) figures of 22, or however many investments in energy by 2030, if you say broadly that it will cost 20% of that to change from high carbon or conventional carbon levels to low carbon levels, which is probably optimistic, then you are saying that somebody has to pay for that difference.

And to expect the public sectors of the world to heap all that money together on the basis of taxation, because there is no other means of them producing money themselves, is, I think, a political impossibility. The only way this is achieved is by a conjuring a trick which changes the source of the money from taxation to something provided by companies in pursuit of at least a chance of their own interest. That is what cap and trade is about. The cap is ultimately the most important thing. The trade does not achieve a reduction. This enables achieving the cap at minimal cost and at minimal political fuss.

Mitsutsune Yamaguchi

When our delegation travels through Europe, we have heard many comments that price signals, to some extent, lead to technology innovation/diffusion. And I do not say that a price signal never induces technology diffusion. But, at least for phase one, there was almost no such effect; it did not lead to technology innovation/diffusion because the initial cap was so loose. And second, in comparison, my idea is a kind of top-runner, energy-intensity approach. In this case, others must catch up to the top runner and this top level itself is gradually rising. So everybody has to improve their technology. Under emissions trading, they can meet the target by purchasing permits to fill the gap. As an economist I can assuredly say that cap and trade, as well as carbon tax, is cost-effective. This is true. If we value cost-effectiveness in environment policy as the first priority, we should introduce cap and trade. The point here is whether we can reduce our emissions drastically by this policy in a long run. I doubt it.

Finally one word on the technology-push perspective. What I did not hear about in Europe was government R&D. For example, in phase three it says 20% of auction revenue should be used on R&D, but it says "should" and not "shall." I guess the UK government, or some government, was against such stringent requirements. Maybe the Japanese Minister of Finance would say the same thing. So, we do not know whether under that system technological innovation will be promoted.