because it pays those countries to avoid strict emission control policies. Future studies of the economics of climate change should look at offsets not just for their impact on compliance costs but also for their influence on strategic interaction between industrialized and developing countries. The analytical questions are not just whether offsets are “additional” but whether they produce positive (or even negative) leverage on the emissions from developing countries. Over the long term the largest leverage that the industrialized countries have on the global warming problem will come from their strategy to engage developing countries. Because of perverse incentives embedded in any offsets scheme, one element of that strategy must be a credible sunset for offsets.
Second, the design of CDM rules has been highly political, which is hardly surprising since it is mobilizing and allocating large amounts of capital and the other benefits that flow alongside investment. At present, the CDM pipeline is probably worth several tens of billions of dollars. By 2020, the Copenhagen Accord envisions that the CDM and other offsets markets might annually channel $100 billion to developing countries, which would exceed total current annual spending on official development assistance from all sources for all purposes. Politically organized interest groups have favored some technologies (e.g., small hydropower) while abhorring others (e.g., nuclear power). Those forces are evident in the current and prospective flow of CDM credits.
The most important effect of politics on the design of the CDM has been the strong political pressure to generate high volumes of offset credits at the expense of quality. Firms and governments in industrialized countries seek offset credits to assure that they will be able to comply with strict emission targets. Developing countries that host projects want to maximize the revenues that are linked to the flow of credits. By contrast, the interest groups that would press for higher quality and strict administration, which would lead to much lower and more uncertain flows of emission credits, are much less well organized and influential. A similar constellation of political forces is now mobilizing around U.S. policy on offsets. There are well-organized industrial forces that favor generous offsets rules. (Those forces are not wrong—indeed, if well administered, an unfettered offsets system would be a good policy.) But the crucial administrative questions have been left vague and are most deferred until the future. Interest groups that would favor strict administration are much less coherently organized. One remedy for these pressures is to set a credible safety valve on emission prices, which would remove the incentive for purchasers of offsets to seek high offset volumes as their only means of managing compliance costs.
Third, many of the troubles in the CDM arise because it was designed by committee with very little attention to political economy. A much more strategic approach to the design of offsets is feasible and badly needed.
In theory, most of the power in the creation of an offsets market originates with the largest purchasers of offset credits—today the EU and Japan (via the CDM) and eventually the United States, once a U.S. emissions policy is reliably in place. So far the EU and Japan have ceded much of their potential power to the Executive Board created under the Kyoto Protocol to manage the CDM. That Board is a cumbersome and largely ineffective system for administration. This is not news to the governments of the EU and Japan, but these countries have not pressed harder for such reforms nor created their own, better parallel system because they had no other alternative means of meeting the Kyoto targets.
The United States has the luxury of starting over. The United States should use its market power more wisely by setting rules for price offsets according to quality, creating a system of buyer liability, and adopting other rules that will create stronger private incentives to identify and reward (with higher prices and better delivery terms) high quality projects. As such, U.S. rules could create a competition for quality rather than a race to the bottom. This is a hypothesis that merits some modeling effort since it suggests that the United States could have inordinate leverage on the quality of worldwide efforts to engage developing countries through the rules it sets in its home market.
Fourth, the studies presented at this conference suggest that the offsets supply market will not be competitive. A few activities—forestry in Brazil and possibly Indonesia as well as the electric power sector in China—are likely to be the largest suppliers of offsets.81 All are dominated by government-owned corporations or government
The actual supply of forestry credits will depend on the combination of available forestry projects as well as the systems for administering those projects. Brazil combines large potential supply of such projects with decent public administration and could be the dominant supplier in forestry. In energy-related offsets, see Blanford (2010) for a striking set of supply curves suggesting that perhaps half of the supply of offset credits from developing countries would come from the Chinese electric sector. See also Victor (2009) for an argument why most of the non-electric activities in developing countries are much more difficult to include in crediting schemes—because monitoring of emissions and government control over the electric sector is usually much more decisive than in most other segments of the economy.