Special Seminar: Co-hosted by RIETI, METI and MOE

"U.S. Climate Change Policy: Where We Are and Where We Are Headed"


  • Date: Friday, April 4th, 2008
  • Time: 12:15-13:45 (Registration desk and seminar room open at 12:00)
  • Language: English / Japanese (with simultaneous interpretation)
  • Venue: RIETI's seminar room (METI Annex 11th floor, 1121)
  • *Co-hosted by RIETI; Ministry of Economy, Trade and Industry (METI); and Ministry of the Environment (MOE)
Speaker Eileen CLAUSSEN
President, Pew Center on Global Climate Change
Commentator YAMAGUCHI Mitsutsune
Professor, Research Center for Advanced Science and Technology, the University of Tokyo
Moderator KAWAGUCHI Yoriko
Member, House of Councilors


The Pew Center is an independent, non-profit, non-partisan center founded in May 1998. The five major program areas are scientific and economic studies; analyses of domestic and international strategies; outreach activities with the federal government, state governments, and the business community; solutions; and communications. There are over 40 companies involved in the Business Environmental Leadership Council.

When we think about the history of climate change activity in the United States the most important date to remember is 2003, when the first mandatory economy-wide cap-and-trade bill was introduced into the Senate by Senators John McCain and Joseph Lieberman. Although it was put to the vote on two occasions, it did not pass. It did, however, spur the 2005 passage of a non-binding resolution supporting mandatory climate action.

In the absence of real leadership at the national level, 23 states are pursuing their own cap-and-trade programs through the Western Climate Initiative, the Midwest Greenhouse Gas Reduction Accord, and the Regional Greenhouse Gas Initiative in the northeast. In addition, 10 states are observing the discussions and may participate at a later time.

In terms of automobiles, California is leading the way with its efforts to develop vehicle emissions standards, and 17 states are hoping to follow its lead by introducing standards that are more stringent than those just agreed to at the national level.

Over the past couple of years in particular, the business community has become increasingly active. The most important development in that regard was the founding of the United States Climate Action Partnership (USCAP), a coalition of six non-governmental organizations and 26 corporations, representing many different sectors of the economy, which supports mandatory cap-and-trade legislation. USCAP supports a long-term target with a series of mandatory emission reduction requirements. The members of USCAP appreciate this performance-based, market-driven approach because they want the flexibility to determine how to comply and the opportunity to outperform their competitors in a greenhouse gas reduction market. USCAP is a CEO-driven partnership that works with members of Congress to have legislation that will provide a price on carbon and also some certainty about what the reduction schedule will be. Due to early activity in Congress, the activities of many U.S. states, and the support of significant members of the business community, it is inevitable that there will be federal legislation for a national cap-and-trade program by 2010.

In 2007 and 2008 to date, there have been 178 congressional hearings on climate change, and a total of 200 bills have been introduced that address climate change issues in one way or another. In 2007 the Energy Bill passed through Congress and was signed by President Bush which includes energy efficiency standards, a renewable fuel standard, and requirements for improving the efficiency of automobiles. This Energy Bill will have important implications for the climate change issue.

Senator McCain, the presumed Republican presidential nominee, has long supported a national mandatory cap on greenhouse gases in the U.S. He supports a 60% reduction in greenhouse gas emissions by 2050. The two Democratic candidates, Senators Hillary Clinton and Barack Obama, both support an 80% reduction in emissions by 2050. All three senators are co-sponsors of current cap-and-trade bills. A mandatory cap-and-trade bill, co-sponsored by Senators Lieberman and John Warner, passed the main Senate committee last year. For a major controversial bill to pass in the Senate, it requires the votes of at least 60 senators. Currently, at least 48 senators have shown their support for a cap-and-trade bill to limit greenhouse gas emissions.

The Lieberman-Warner Bill proposes an emissions reduction schedule that is not much different from that proposed by USCAP. Although the bill does not allow international offsets, it does allow companies to use emissions credits purchased from foreign emission markets for up to 15% of their compliance obligation provided those markets are of comparable stringency to the American system. The bill also allows firms to use domestic offsets for up to an additional 15% of their compliance obligation, although only agricultural, forestry and land use projects are eligible. In this bill, 74% of the allowances are initially allocated primarily to electricity generators, energy-intensive manufacturers, states, and low-income energy consumers. A total of 26% of the allowances are auctioned, with the revenues primarily going to low-emission technology deployment, assistance to low-income energy consumers and adaptation. Envisioned in this bill is that by 2031 almost 70% of allowances will be auctioned and that electricity generators and energy-intensive manufacturers will receive no free allowances. It is very likely this bill will change in order to win the support of 60 votes in the Senate.

The House of Representatives is not as far along on the issue of climate change as the Senate. Still, climate change policy is a top issue for Speaker of the House Nancy Pelosi, as well as for Congressmen John Dingell and Rick Boucher, who are working on their own cap-and-trade bill. Since only a majority is required in the House of Representatives and there are moderate Republicans who support a cap-and-trade bill, it seems likely that a bill will pass the committee stage and then the House.

Due to USCAP and the emphasis placed on cap-and-trade by Congress, it seems likely that national legislation will be a cap-and-trade system with a number of other complimentary measures. This is because the science is clear that there is a need to drastically reduce greenhouse gas emissions, and what is called for is a declining limit or cap on emissions. If we are to implement it at the lowest cost to the economy, the best approach is emissions trading that allows the reductions to take place where they are the least costly to bring about. A national cap-and-trade system will provide incentives for innovation because it does not specify particular technologies or practices. It will also ultimately allow the U.S. to link to other trading systems such as the European Union's Emissions Trading System.

The first steps in designing a cap-and-trade system are to decide whose emissions should be covered and then to set an overall cap on those emissions. Following that, allowances are then allocated to those who are covered or auctioned up to the level of the cap. Emitters are required to submit one emission allowance for each ton of greenhouse gases they have emitted by the end of the compliance period. To meet their compliance obligation, emitters may trade allowances on the open market.

There are four key issues in designing a cap-and-trade program that make it challenging in the U.S. and probably elsewhere as well. These challenges are: setting the targets and timetables, deciding on allocation or auction of permits, ensuring that the costs are as low as possible, and handling competitiveness and trade issues.

Setting the targets and timetables for emission reductions in a way that is scientifically defensible but also economically sustainable requires an assessment of how much can be reduced economically by a particular date, and how the reduction schedule can best provide the incentives for the development and deployment of key technologies.

Permits can either be allocated for free, based on past emissions for example, or can be auctioned with the revenues going to the government. Deciding how much to allocate and to whom, and how much to auction, is a distributional question and requires difficult political decisions. There are a number of entities that could receive allowances: emitters only; all product generators or producers; those entities most affected (for example, to ease the transition for high-emitting industries); or state/federal government, which will be implementing complimentary policies that will also reduce emissions. If policy-makers decide to include an auction, they will have to decide how many allowances should be auctioned and how to use the revenue that is generated (for example, auction revenues could provide money for technology development or for adapting to climate change).

One of the main obstacles to enacting climate legislation in the U.S. is a concern about the costs of the program, especially with current fears of a recession. A cap-and-trade program is inherently cost-effective but some designed features can assist with keeping costs down. These include offsets (low-cost emissions reductions from outside the cap-and-trade program) and flexibility about how and when allowances can be used, for example by using banking or borrowing. Other options include a Carbon Management Board with the discretion to make adjustments to the program, for example, by allowing greater use of offsets or what has been called a safety valve (which is a limit on the cost of an allowance.)

An issue that is a concern to U.S. businesses and to policy-makers relates to competition with countries not covered by an emissions cap. Emitters may decide to move to a non-covered country taking their emissions with them. A less controversial and perhaps more effective approach might be to develop international sectoral agreements that can set standards globally across a particular sector and thereby help to maintain competitiveness among different countries. Short-term concerns can be addressed through a more generous allocation to vulnerable manufacturers, but border adjustments and other mechanisms are also under consideration.

It is important to point out that a cap-and-trade program by itself is insufficient to deal with this problem. Additional policies targeting research and development are needed to further drive the economy toward low-carbon technologies. Policies to address those sectors that are not easily covered in a cap-and-trade program, such as land use and transportation, may be warranted. With regard to the transportation sector, these could include fuel efficiency standards or requirements for low-carbon fuels.

Emissions trading in the U.S. has been used since the 1970s. The Acid Rain Program enacted in 1990 covered sulfur dioxide emissions from power plants. It was enormously successful. It achieved its pollution reduction goals at approximately half the cost of traditional regulation because it allowed the reductions to take place where they were cheapest and because it included a strict monitoring system that provided assurance that a ton reduced was absolutely a ton reduced. This last point is crucial: if the system does not have integrity it will collapse. Measurement, reporting, and verification are all important elements of a cap-and-trade program.

The European Union's Emissions Trading System is the world's most ambitious and far-reaching example of a cap-and-trade program. The initial design includes limits on carbon dioxide from approximately 12,000 facilities in 25 member states and covers power plants in five major industrial sectors. The first, or trial phase of the system was just completed. The system is the first of its kind and size and it has established a functioning market in a relatively short time.

Europe now has a price for carbon dioxide that is being included in business decision-making. Within the short three-year learning phase some emission reductions were realized, but the phase was not perfect. There was a lack of sufficiently verified data either by sector or by installation. When there was a sharp decline in the price of allowances in the middle of the trial period, when more accurate data was released, it was clear there had been an over-allocation. Price volatility is also a problem. There was controversy surrounding high electricity prices and consequent higher corporate profits resulting from the free allocation of allowances. This occurred even though the allowances were allocated at no cost, because many in the electricity sector passed along their costs. An inadequate understanding of how electricity is regulated in each of the member states caused this problem to arise.

But the EU learned from its mistakes and has already made changes to its system to assure there is a sound basis for allocating emission allowances in the future. These proposed changes include having much better data on emissions, having a more centralized cap setting and reporting process, allowing an unrestricted banking of allowances between compliance periods, and having an increasing reliance on an auction, in which the costs can be passed through to consumers.

On the international side, with the enactment of mandatory domestic greenhouse gas limits, the U.S will be far better positioned to help lead the effort to establish an effective international regime because Americans will know better what they are prepared to commit to. This does not mean that the U.S. will ratify the Kyoto Protocol; the country could not possibly meet its target at this late date. In the U.S., the Kyoto Protocol is so politically tarnished that the country cannot return to it. It is unlikely that the major emitting countries in the developing world would agree to binding, absolute targets. The U.S. would enter into a binding international commitment only if the major emerging economies assume some form of binding commitment as well.

What is needed to win the support of the U.S. for a post-2012 agreement is an integrated, multi-track approach in which all major economies have binding commitments, albeit varying ones. The Pew Center believes the most appropriate form of commitment for the U.S., Japan, and other developed countries is an absolute economy-wide emissions target. But the major emerging economies could have policy commitments such as renewable energy targets or fuel economy standards, or they could participate in international sectoral agreements. What is important is that all these commitments be measurable, reportable, and verifiable, and that together they put us on the path to stopping and reversing the growth in global emissions.

In conclusion, the U.S. will have mandatory cap-and-trade legislation very soon. It is possible in 2008, more likely by 2009, and almost inevitable by 2010.

Mitsutsune Yamaguchi

Regarding U.S. domestic cap and trade bills, three points need to be mentioned. The first is the cost. According to the U.S. Environmental Protection Agency (EPA), the cost (GDP loss) necessary to comply with the Bingaman-Specter bill is estimated as 0.5-1.4% in 2030 and 0.9-2.9% in 2050, whereas that of Lieberman-Warner is estimated as 0.9-3.8% in 2030 and 2.4-6.9% in 2050. The reason of such a big difference is because the former has price cap and the latter does not. Needless to say, in the United States costs are very important, so this is a critical consideration for the future. Once such safety valve will be finally introduced in the Lieberman-Warner bill, the bill will no longer be called "cap and trade" as the cap will become flexible. This important point is yet to be seen. The second is on initial allocation. One concern is how to do with initial allocation, i.e., what will be the portion of initial allocation between auction and grandfathering. Also in case of grandfathering, on what formula initial allocation to covered sector facilities should be based upon. In Japan initial allocation is recognized as the most difficult and controversial issue.

The third is trade measures and their relationship with GATT/WTO: in January the EU unveiled EU ETS Phase III. At the stage of draft proposal, trade measures were proposed in clearer way, but in the final proposed version the description was toned down. Several U.S. bills contain same kind of trade provisions. In my opinion, this is quite dangerous. Once the provision is deemed as GATT-legal, various trade measures will be introduced because of difference of wages, tax system, etc. This will lead to the collapse of free trade regime.

Today, I would like to focus on the international aspect of U.S. climate policy. The United Nations Framework Convention on Climate Change (UNFCCC) stipulates in Article 2 that the ultimate objective is "stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system" with three caveats for achieving such a level: within the time frame sufficient to allow ecosystems to adapt, to ensure that food production is not threatened, and to enable sustainable economic development.

Especially important is the last one; compatibility between the economy and the environment. The Intergovernmental Panel on Climate Change (IPCC) reported on this, one of the lead authors being myself, seeing it as a double-edged sword i.e., climate change adversely affects sustainable development. Conversely costly mitigation measures could have adverse effects on economic development. So a proper balance must be pursued.

Halving global emission in 2050 is becoming popular among global leaders as a long- term target. Without agreement on the ultimate objective, however, no one can explain what for we need to halve our total emissions by 2050. Apart from that, let us examine the feasibility of that target. According to RITE DNE21+ model, to achieve the goal, developing countries' emissions must remain 125% in comparison to 2000, even if developed countries attain zero emissions. No one thinks this is feasible unless some breakthrough technology is introduced at a reasonable cost.

I agree with the U.S. position that Ms. Claussen mentioned earlier: commitments by all major emitters with different types and levels of stringency as well as a multi-track framework. I think it is particularly important to ensure the participation of major emitters such as China and the U.S.

For this purpose, pledge and review, I believe, will be effective. Recently I estimated the effectiveness of pledges under three different cases. In the first case, Japan is assumed to pledge, by 2030, a 30% improvement in energy efficiency compared with 2005. The EU is assumed to pledge a 20% reduction by 2020 (base year 1990), and a 60% reduction by 2050. The U.S. is assumed to pledge a 20% reduction of gasoline consumption (base year 2003) then a 50% reduction by 2050. APEC is assumed to pledge a 25% improvement in energy efficiency by 2030 (base year 2005); if China, India, and South Africa follow suit, the global reduction will be four gigatons of CO2 in 2020, and six gigatons in 2030. I will now skip case two (but you will be able to see it in the slide).

In case three, Japan's marginal abatement cost (MAC) is assumed to be the same as the EU. Japan will be bound to APEC's stringent criteria - a 30% improvement in energy efficiency by 2020 (base year 2005) and 40% by 2030. This additional condition makes Japan's marginal abatement cost much higher than EU. China and India are assumed to have more stringent commitments as shown in the slide. By these measures, the global reduction would be five gigatons of CO2 in 2020 and eight gigatons in 2030.

Regarding the sectoral benchmark approach case, major energy-intensive sectors in Japan, such as power generation and steel production, are assumed to be the best top runner. This cannot be done overnight and will require the rest of the world some sort of grace period for gradually catching up with the top runner. Reduction potential by sectoral approach was calculated as follows. Assume Japanese energy efficiency (CO2 intensity in case of power generation) is 1.0. By 2020 this will be improved up to 0.95. Annex 1 countries energy efficiency will catch up Japan's 2005 level by 2020 and developing countries efficiencies will be improved to 1.2 in energy-intensive sectors. Though these assumptions are in a sense arbitrary, this will be within a plausible range. As a result, the biggest reductions would be experienced by the U.S. and China because both countries energy efficiencies will be greatly improved and also two countries emission volume itself is huge. The highest cost would be borne by Japan because energy efficiency is already high in Japan, so the marginal cost for further improving that is going to be quite high. This would result in 6.3 gigatons by 2020, and 8.8 gigatons by 2030. This is one of several ways of thinking that have been put on the table.

Finally, we have long been talking about developed countries and developing countries, but this categorization is based on the UNFCCC of 1992. If we look at the track record of past emissions, the highest is the U.S., followed by China. If we think of future emissions, situation changes rather drastically. So this categorization of developed versus developing is rather awkward. Scientific research with this respect should be pursued.

Eileen Claussen
I would like to respond on two issues: one is cost, and the other is technology. Professor Yamaguchi had a slide which showed the costs of the Lieberman-Warner Bill and the costs of the Bingaman-Specter Bill. And of course the Lieberman-Warner costs will be greater; that is because Lieberman-Warner will actually reduce emissions. With Bingaman-Specter, the price cap at $12 kicks in early and emission reductions cease, so of course there is very little cost. But I think we need to understand better what the economic models can and cannot tell us. And my main point here is that they can give us insights but they are not useful for giving us absolutes like absolute reductions in GDP.

So why do they not give us absolutes? This is because each of these models has a series of built-in assumptions about economic growth and emissions growth, about the speed of technology development and deployment; and it depends on how you decide on what assumptions to use as to what kind of result you will get. So if, for example, you decide that technology will not be available for a very long time, of course the costs will be higher. If there is greater growth and baseline emissions are higher and therefore you have more to reduce, of course the costs will be higher. If you do not include the costs of the damages that would be avoided from dealing with climate change, of course you are going to have a distorted picture of the end result on GDP. So I think it is a mistake to look at very specific numbers and assume 30 years from now or 20 years from now that we know exactly what the cost will be. But I do think the models can inform policy choices because they can provide some comparisons. If, for example, you show that more offsets can be used, the prices will come out to be lower. So maybe your policy should include more offsets. If you include a safety valve, and the level is too low, you can see what that does to your emission objectives. So I believe these models are very useful, but they should not be used to give absolute numbers.

The second issue that I would like to talk about for just a second is technology. I agree with Professor Yamaguchi completely on the importance of technology; but I believe also that there are technologies available now that have not been deployed. And I also think we must have massive investment in future technologies, because we will need them if we are going to reduce emissions to the necessary level at a cost that is sustainable. It is our view that you need both what I would call a push and a pull to get those technologies developed, and in the marketplace. And to us, that means you need some requirements that will pull the technologies in because people will have to meet certain objectives. And quite honestly, pledges do not typically add up to the kind of reductions that the science demands. And then you need to push: you need investments and technology at the same time to get the required result. We do a lot of work with a lot of companies, and all of it suggests that a price on carbon, some requirements so people know how much to invest and what their obligations will be, and then money to go into technology development, are the necessary elements to address this problem in an economically sustainable way.

Mitsutsune Yamaguchi
As you suggested, there is a limit to the economic models. This model is just for reference, but I would like to add one thing, the Cost Benefit Analysis. Of course, benefit (that is, avoided damages by climate policy) is rather difficult to measure, but usually such debate has been non-existent; focus has only been placed on the cost side. So how can we compare it with the benefit? This is an important task. From the converse side, as Ms. Claussen said, I think that the model is skewed for a different reason. The model assumes perfect competition and that all parties behave rationally and pursue (short-term) profit, but what about the cost of cap and trade? If there would be no obstacle in the market, and if economic theory comes into full play under such an assumption, this would be the cost. But the actual cost is higher, and that is mentioned in the IPCC report as well. When you look at the model, the cost assumed is too low, and therefore I do not deny what Ms. Claussen said, and she is very right on that point, but when we look at the cost, we must say that it is only a theoretical cost, and not the real cost. That is my first point.

My second point is regarding countries making a pledge. This means that each country makes a pledge legally binding or in the case of Japan, it can make a pledge institutionally binding. At any rate we assume that each country will act responsibly to achieve the target.

My final point is regarding technology push. In the case of carbon capture and storage (CCS), it is not possible for private companies to make enough investments, so government-led R&D is required. Capping emissions may induce, to some extent, technological improvement, but this in not enough. Same kind of market failure as public goods will occur.

One point that I have failed to mention: at the bottom of this table (slide P.5). The expected reduction ratios of two U.S. bills are shown as well as that of USCAP. U.S. bills have no link to either a 50% global reduction or the EU's two-degree target. You may say that the U.S. emission target is different from a 50% global reduction. All countries make reductions to the extent possible, and then we aggregate them. If we find such an approach to be successful, then we will try to expand on it. This is what I mean by using the term "pledge and review."

Question and Answer Session

Q : What kind of cap and trade is ideal? And is it allocated upstream or downstream, and to which sectors?

And a related question: in what way could voters or citizens be persuaded to accept this? What about cross-border linkage?

Eileen Claussen : It is very hard to talk about an ideal allocation, but I think there are probably some principles that we can think about here. It is very expensive for certain sectors and certain companies to have to comply with a set of reduction requirements. One way to ease the burden is for them to receive an allocation, because it actually is money. That is what is really being distributed. In cases where you would like to help an industry that is going to have significant costs, and where you don't want the costs to be passed through to the consumer or not to all of them at once, I think prices will have to rise for consumers. However, you don't want it to be dramatic and abrupt. You want to smooth that curve out. So I think in such cases, you may want to make sure that you give some allocation to the company, and not let them pass on the costs. I do not know the situation in Japan, but in the U.S. 80% of the coal-burning utilities are in states that are regulated at the state level, which indicated an issue about when you can pass or not pass the costs on. So in those kinds of cases I think there is a reason to make sure there is a substantial allocation. If you are concerned about competitiveness, such as in an energy-intensive industry, and you want to make sure it is not disadvantaged right away by having to reduce emissions, you might want to make sure that it has enough of an allocation so that the playing field is level. You could also solve that problem with an international sectoral agreement, such as with steel. But before reaching that, some help may be needed in the form of allocations. On the other hand, there is also value in having some amount of auction. Not everybody should get an allocation for free, and certainly not forever because you really want to see technological change. That would not get you where you need to go. What about those places where the costs will be passed on, and you don't really just want to enhance profits through this system? I believe this is case by case, and much care should be taken in seeking a relative balance between how much you allocate and how much you auction, and to whom you allocate.

Q : If a cap-and-trade bill passes in 2009, whichever bill passes will draw a grand plan since each bill calls for reducing U.S. emissions to 1990 levels. But the EU is asserting, at a minimum, a 20% reduction from the 1990 levels by 2020; a minimum 20% gap between the U.S. and EU. How could this 20% gap be filled?

Eileen Claussen : It is important to be realistic in what you can expect from different countries at any given point in time. The U.S. did not reduce any emissions from 1990, it grew emissions. So to suggest that the U.S. and EU at this point, or by 2020, would do the same thing is, I think, totally unrealistic because that would be saying that the EU would reduce an additional 20% from where they are now, and the U.S. would reduce 40% or more from where they are now. Quite honestly, cannot possibly happen, no matter how desirable it would be, or how sorry you are. So I think it is better to look at it in terms of going forward, looking at where we are now and how much we can achieve. If you look at Lieberman-Warner or the California program, which is roughly the same, the amount of reduction is actually quite similar: it's as if you go back to 1990, and that base year; it is way out of proportion. It would be nice, but it is not going to happen. I certainly say that all the time to ministers in the EU whom I talk to. At this point, they are certainly not willing to accept anything, but then again there is no reason that they should because we actually do not have legislation or a real program in place at the moment. So I think that once that is done, there will be a more realistic view of what we can expect, both of the U.S. and also, quite honestly, of China, India, Japan, or other countries because it is not the same for everyone.

Q : What is the prospect of the Lieberman-Warner bill passing in Congress?

Eileen Claussen : I think there is some chance that it will pass, but not exactly as it is at the moment because the votes that were required in the committee do not really reflect the Senate as a whole, and many of the "swing votes" we need to add to the 48 we think we already have are from coal states or heavy industrial states, and are not represented on the committee. So I think the bill will have to change in order to get 60 votes. But that said, I think the basic structure will probably remain. I think the targets, certainly the 1990 levels by 2020 and the long-term target will remain, but there will be some changes. Then you also have to look in our system at what the House of Representatives will pass, which I think will not be the same either as Lieberman-Warner for different reasons. And then, in the U.S. system, there is a conference to seek agreement on a bill which again is probably not the same as either of the bills that pass the House or the Senate; and then of course we need a president to sign it. The president may or may not engage in the discussions there to make sure this is something that everyone agrees with.

Q : Cap and trade: this regime is about numerics of emissions; fixing the volume and the price fluctuates on the market. But there is a reverse way. We can fix the price and then the volume could fluctuate on the market, which would probably have the same effect as if the price is set and fixed at an appropriate level. Do you think that this kind of methodology would be feasible in this area?

Mitsutsune Yamaguchi : According to an economic textbook, tax and emissions trading are theoretically the same. But there exist one big difference when abatement cost revealed to be much higher than expected. The environment is not deteriorating because of the CO2 emitted this year, but rather the accumulation of the CO2 emitted in the past century. Therefore the slope of marginal damage function is not so steep, but in case of abatement cost, the slope is steeper. So from that assumption, theoretically the risk of mistake (social loss by deviating from the optimal abatement point) would be lower in the case of tax.

Another important point: in the case of cap and trade in global policy, will so much reduction truly happen? No, that cannot be the case. This is the important point, because without technological improvement, it will not be possible. So it is an illusion to think that there is a cap where reduction would be achieved, especially on the global front, because there is no system that would penalize countries if they didn't achieve the target.

Eileen Claussen : Let me just make one comment here. You really are trying to compare cap and trade with a tax. To me, one of the major differences is that with a tax, the government sets the level, and with a cap and trade, the market sets the level. I, for one, would much rather the market set the price than have the government try to figure out what the right price would be and then have to make a series of changes which could also mean volatility in the price. So I much prefer a cap and trade to a tax. And I also think that the advantage of a cap and trade, the main advantage, is that you will get the reductions where they are cheapest, whereas with a tax there will be an incentive to reduce, and everyone will have this incentive because they will have a particular rate of a tax. However, companies, for instance, won't have the ability to say, "I can reduce more and make some money on it because I can trade my extra allowances."

Q : What approach is the incoming U.S. administration likely to take toward climate change?

Eileen Claussen : I believe that any new administration, no matter who is elected, will support a binding international agreement where it is not just a matter deciding what you can do, but rather taking what you can do and negotiating it with others to make sure that the level of ambition is sufficient. That is pretty much a given. I also think that one has to be realistic about what can be expected from different countries. I do not believe that the major emerging economies will in this next round ever agree to absolute binding targets. Such a requirement would essentially be saying you do not want an agreement. I don't think any of the new administration possibilities will go in that direction. So I think you do need an approach which lets the developing countries do different things than the developed countries. But I think the standard will be that it must be a binding commitment of some kind, and it must be significant. It doesn't have to be everything, but it must be significant.

Then you asked whether the Senate would ever ratify such a treaty. There is some understanding among senators about what is possible, and what is not. Senators Biden and Luger, the chairman and minority leader respectively on the Senate Foreign Relations Committee, have been very engaged in this. In fact, they and others joined us in looking at the Pocantico Dialogue. The senators are starting to form a study group to look at what might be internationally possible, and to try to assist with getting to a meaningful international agreement. I think over the next year or two there will be increased emphasis in the U.S. on what a global agreement might look like, in the Senate. At the same time I think that whoever is elected will have to get a little smarter about what is possible and how to approach the negotiation.

Q : Ms. Claussen, how can you introduce positive incentives for technological innovation through caps? Professor Yamaguchi, why do you think caps will not lead to innovation?

Eileen Claussen : I think to get technological innovation, a clear idea is needed over a long period of time about what will be required; in other words, a set of caps. That is why a long-term target is also important, because it sends a signal about where we are going and what will be needed. You can look at examples of companies as a way to look at this. One that I know quite well is General Electric, which is obviously a very large company that in recent years has been able to put together a portfolio of technologies of different kinds that would do well in a carbon-constrained world. They have wind-integrated gas-combined cycle for coal burning, they are doing work on sequestration, they have efficient locomotives, efficient engines: in other words, they are preparing for a time when there will be a series of caps. I think that kind of certainty about the future will lead to a great deal of innovation, because succeeding in a carbon-constrained world requires actually possessing the technology that will sell in such a world. To me, the idea of having on the pull side a very clear idea of where and when you are going, will assist in innovation. I also think, however, that you need investment from the public sector as well. You need to make sure you allocate sufficient money toward certain kinds of technologies where the need is huge, and where the private sector, on its own, cannot do it. I would agree with Professor Yamaguchi's point about carbon capture and sequestration, because the Chinese continue to burn coal and we are going to continue to burn coal. If we do that, we have to figure out this technology, and we cannot do it only with the private sector. We need substantial government investment as well.

Mitsutsune Yamaguchi : This is a very important point. Most likely, when capped, there will not be much technical innovation. This is shown in Phase I and Phase II in the EU. Phase II has just started. I have been there and discussed this issue with my EU counterparts as well as government high officials and industry representatives, but there have been few cases of innovative technology coming out of that regime. So the issue would be: without the long-term scenario there is no good signal in the market, but when we say long-term, can we really decide on a cap to be introduced 30 years from now? The economic activity fluctuates dynamically and therefore even when we make a decision, it is going to need amending immediately. In other words, whatever is decided may not actually take place. I think realistically that it would be difficult for such goals to be fixed for decades. Regarding the power generation or energy-intensive sectors, take factories for instance. Once you have built a factory you cannot tear it down in five years. It will be there for 30 years, 50 years. With that in mind, about five or eight years is not a sufficiently long enough term to make investment immediately, but at the same time I have no intention of saying that this is exactly the same as no signal in the market. For example, when the liquid crystal, flat-panel television was first launched it was quite expensive, but it was very attractive, saved energy, the screen was beautiful, and people paid a premium even though it was more expensive. So technology may be promoted by the private sector and this sector innovates, even without policy, because market demand exists. The hybrid Toyota Prius is expensive but drivers want to show they are eco-friendly by driving one. That kind of incentive is in place, so market pull is effective. But when it comes to electricity, situation is quite different. No one knows what this is made of, so, for example, people never know whether electricity they use is generated from fossil fired power plant or from renewable energy such as solar or wind. In such a case only price of electricity matters. Other differences are invisible for consumers. Since it is costly to shift to renewable energy, and also power generators will not be able to add on their additional costs to prices, they are unwilling to invest in the technology developments required for such a shift, including CCS. When one company invests, it has to bear all the losses. However, if one is successful, positive externalities (benefits) are equally enjoyed by competitors. Therefore, companies barely invest in areas in which positive effects on the environment are not perceived by consumers. In these cases, market pull is never enough and that is where government money is required. I am not saying that caps have no impact whatsoever in technological innovation, but in a cap-and-trade regime, as with the EU example, which is very short, we find it is difficult to promote technological innovation.

Eileen Claussen : It is really unfortunate to use an EU example for a couple of years with a short-term target, because that is precisely the point. A very short-term target does not stimulate much innovation. But I think we are now talking about a series of long-term targets which can give you the uncertainty that you will need new technologies.

Q : Professor Yamaguchi may have alluded to cost versus benefit. In a serious way, how can we perceive "benefit," and what should be the approach for thinking of benefit?

Mitsutsune Yamaguchi : A very good question! Cost benefit analysis compares cost and benefit and only when benefit outweighs cost, introduction of such policy can be justified. This is the basic principle. In the case of global warming benefit is measured as avoided damages. If environmental damage is 100 and it will be reduced to 80 by introduction of mitigation measures, avoided damage of 20 is counted as benefit. But there are several difficulties to apply this approach to climate policy. For example how we can measure non-market damages (such as loss of biodiversity) in monetary value? If we have an international standard on how to convert these damages into monetary terms, we are able to compare cost and avoided damage (benefit). In addition there are serious debates among economists on what discount rate we should use in converting future damages into current value. The famous economist William Nordhaushas conducted cost-benefit analysis since 1990. Whether his estimates are reliable or not depends on the assumptions. But suppose his estimates are correct, a 50% reduction by 2050 is far above the required level for tackling climate change. And then Sir Nicholas Stern took issue with that. In the Stern Review on the Economics of Climate Change he reviewed the costs and benefits based upon different assumptions. The most controversial is that he used pure time difference discount rate of 0.1%. But as he later examined by himself, if he uses alternative discount rate of 1.5%, avoided damage (benefit) will be reduced by 70%. And as Nordhaus pointed out later, if the same discount rate as used by Nordhaus is used, the picture changes drastically. It tells us that cost of drastic measures far exceeds benefit. In addition benefit advocated by Stern Review is not real benefit. In the book, benefit is calculated on the assumption that all the damages disappear due to climate policy. This is not true. So it is merely estimates and not cost-benefit analysis in the true sense of the word.

Why do we have to conduct cost-benefit analysis although we know it is difficult? The global problem is not only global warming; there are eight U.N. Millennium Development Goals, including poverty, hanger, diseases, etc. Global resources are scarce but we have to allocate certain resources toward each problem. If we allocate certain portion of our resources to a certain issue, this means that other problems will not receive that portion of resources. This is a matter of choice, so following cost and benefit we must be able to know to which area to which we should delegate our resources. This is a very difficult question and not something that can simply draw conclusions on by using a computer. But if the cost-benefit notion is forgotten, it will not be possible to allocate resources toward each global problem appropriately.

Eileen Claussen : I agree with a little of that. I think that the issue is how to cost the damages that are avoided. And I do not believe we have good methodology at the moment for doing that. We have anecdotal information; we know about insurance costs from storms and we know there will be more storms, but that is not really enough to do it in a scientifically sound way. I do think that the Stern Review for all of its flaws, is the best we have available. I would not subscribe to any of the numbers that he has either on the cost side or the benefit side, but I do think the comparison is probably right, that the costs of the damages would be greater than the costs of mitigation. But how can we quantify that? We do not have a system to be able to do that and we are actually starting to put together some workshops trying to merge scientists and economists in one place to try to figure out the best way to talk about this because this is really important. Otherwise, all we do is focus on the cost of mitigation and then any number looks large and no one compares it to what the cost would be without mitigating.

Yoriko Kawaguchi : I have a completely different answer. Because of my profession I go to many different places, and I discuss the environment. Whenever I discuss the environment the listeners seem to get, we might say, starry-eyed; they show keen interest. Take an issue such as polar bears, which are facing increasing hardships. Many Japanese connect with this issue. I went to one town in Japan and I gave a talk. And after that I asked them, "in order to protect the environment, are you prepared to sacrifice your standard of living?" It was mainly young women, but 80% of the people raised their hands. So this is a reality in Japan. But then I asked the audience, "In order to protect the environment, do you think that nuclear power generation should be promoted?" Then those people agreeing are reduced to about 20% of the audience. That is another reality faced in Japan.

*This transcript was compiled by RIETI Editorial staff.