A paper delivered to the Lavoisier Group Conference, May 2000

The Kyoto Chimera

Alan Oxley

It is widely recognised that there are fundamental weaknesses in the Kyoto Protocol. However, few people will, at this point, admit that these flaws are so fundamental that the Protocol cannot work in its current form. It is currently being argued, at the official level, that there are mechanisms in the Protocol which will address its weaknesses, and that therefore the Protocol can work. These arguments, however, cannot be reconciled to the practice and experience of the international community in negotiating international controls on economic activity, at least during the postwar period.

There are many lessons to draw from this experience of half a century; not the least that it is commonplace for politics to triumph over economic common sense. This happens sufficiently frequently for multilateral diplomacy to have developed diplomatic tools to handle the problems which such triumphs occasion. When confronted with impractical treaties, or arrangements to regulate global economic activity, governments do at least one of three things, sometimes even all of them.

First, they announce support for treaties when they have no intention of implementing. Second, they simply fail to enact the provisions of the treaties into national law; or, third, they re-mould and re-package the treaties so that the commitments, at least ostensibly, can be honoured.

There is no reason to suppose that the Kyoto Protocol will be handled any differently from this time-honoured procedure. But it is a cause for concern to note that this historical experience does not appear to be manifest in the current policy of the Australian Government towards the Kyoto Protocol. The current direction of policy, articulated strongly within the Canberra bureaucracy, is to anticipate that the provisions of the Kyoto Protocol will be implemented, and to implement, unilaterally, a substantial increase in the price of energy in Australia in order to achieve reductions in CO2 emissions. The decision to mandate a 2 per cent renewables target for electricity generators by the year 2003? is the first tranch of these price increases.

In the likely event that the provisions of the Kyoto Protocol are not implemented by other signatories to the Treaty, where would this leave Australia? Australia would have reduced its global competitiveness because it will have increased the domestic price of energy. And will Australia's efforts (assuming a connection between CO2 emissions and global temperatures) lead to a reversal of global warming? No, because such policies, while having a major impact on Australia's economic position within the world, would have only a minuscule impact on global CO2 emissions (arguably impossible to detect) because the most rapidly growing energy producers, India and China (amongst other developing countries), have refused to constrain their CO2 emissions.

If the Australian Government wishes to make a sensible contribution to reduction of greenhouse gases when others do not, and do it in a way that does not result in a reduction of our global competitiveness, it would be better to concentrate domestic policy on funding research to improve the efficiency of generation and consumption of energy in Australia, rather than imposing cost penalties on energy production.

Why the Kyoto Treaty Cannot Work

There are three fundamental flaws in the Kyoto Protocol. Each creates circumstances that our experience of post-war economic history tells us makes Kyoto unworkable.

Fundamental flaw one---Kyoto is a square peg in a round hole

The Protocol aims to reduce global levels of carbon dioxide emissions in 3 ways.

First, industrialised economies (Annexe One countries) are obliged to reduce national levels of CO2 emissions, from business-as-usual projections, by agreed amounts. Other countries (developing countries and Eastern European economies) can also make such commitments but it is not compulsory for them to do. (Russia probably will and Argentina might). Two of the world's biggest emitters of CO2---China and India have said they will not.

Second, countries which reduce emissions (Annexe One countries) are encouraged to develop a global system of trading rights (but only amongst themselves) to emit CO2.

Third, industrialised economies and developing economies can set up projects for "Joint Implementation". It is envisaged that they will collaborate in projects to reduce emissions in developing countries. There is no compulsion to do this. It is expected that such projects would be funded by industrialised economies.

Fourth, projects to reduce emissions in developing countries can be funded through a "Clean Development Mechanism". The World Bank has made funding available to support such projects. Once again there is no compulsion on countries to participate in this program.

The effect of this complex structure will be as follows. To meet the reduction targets, industrialised economies will have to introduce domestic measures to reduce the consumption of fossil based energy. Some form of tax on the consumption of carbon is most likely. The only other possible mechanism is a rationing system similar to war-time rationing of petrol. The result is that the Kyoto Protocol will create a world energy market with a two price structure---one part of the globe with fuel prices increased through taxes on carbon consumption, and the other in which they are not. Given that figures between A$15 and $50 per tonne of emitted CO2 are now frequently proposed as the likely tax required for CO2 in Australia, the gap between these two international prices for energy would translate to a differential of between A$35 per tonne of black steaming coal, and A$105 per tonne.

Energy is a globally traded commodity. The basic fossil fuel sources of energy---gas, oil and coal---are extensively traded and in some areas of the world, electricity is traded. A number of important commodities and products which have very high energy contents are, likewise, extensively traded.

It is in inconceivable that such a bipolar system could work. The major economies---the US and the EU---would not permit other producers of energy intensive goods to enjoy the competitive advantage of lower priced energy. They would be unable to force other producers to tax their energy at the same price, but they would almost certainly try to use tariffs to tax the energy resources or energy intensive products as they entered their own markets, or to restrict entry with other trade barriers. This option is now under active consideration within think tanks in Europe.

Such trade restrictions would be unacceptable to those developing economies who signed the Protocol. They signed the Protocol only on condition they would not have to accept mandatory ceilings on CO2 emissions. Being confronted with trade restrictions on energy exports would not be acceptable. They could be expected to withdraw their support for the Protocol (removing what degrees of support there is for it from developing economies) and exercise their rights under WTO international trade law to challenge the legality of such discriminatory treatment.

Fundamental flaw two: Kyoto requires regulation of global markets

It is clear that global politics will eventually stop the Kyoto Protocol. It is just as well. The Protocol is an effort to regulate global production and consumption of energy. We have ample experience of what happens when governments try to regulate the operation of markets.

History is replete with examples of failures of efforts to regulate, capture, or corner global markets. There are many famous failures, most of them costing those who tried, billions of dollars. There were several in the eighties such as when the Hunt Brothers in US tried to corner the world market for silver; when the Malaysian Government tried to prop up the world tin market; and the Australian Wool industry tried to put a floor under world wool prices.

There have been some cases where global cartels have been successful in setting prices, the best examples being OPEC for oil prices and the South African de Beers group for prices of diamonds. Economic theory and history tells us that ultimately these efforts fail and that before they do, they generally exact considerable cost on those affected. But even where they succeed for a period, there is a critical factor in that success. It is that the participants in the program or cartel must comprise the greater share of the world production of the product (or consumption if buyers try to control the prices). Efforts at such control do not get past first base if most producers or consumers, or even a significant minority, are not participating.

The greatest weakness of the Kyoto Protocol is that the greater part of either the producers or consumers do not support the commitments to reduce production of energy. Kyoto is an attempt by some producers/consumers to manage and control global production/consumption. It is like trying to make OPEC work without Saudi Arabia. Even if we presume that the United States will ratify the Treaty,(1) it still leaves us with the situation that about half of the producers of CO2 in the world today (and eighty percent of the increased production over the next 40 years)---the developing countries---will not participate in the Kyoto program of carbon withdrawal. Why would anyone expect that a global effort to control and constrain the production and consumption of energy, which is the essence of the Kyoto Protocol, will succeed when only one or two of the key players are really committed?

Fundamental flaw three: a global system of trading permits for emissions is an impossibility, at least in the short to medium term.

There is no longer a consensus among the signatories to the Protocol in favour of a global system of emissions trading. A commitment to establish such a system was part of the package of measures contained in the Kyoto Protocol and for a number of governments, such as those of Australia and the United States, it was integral to their support for the Protocol. The European Union supported that package then, but it has now changed its position. It now wants only fifty percent of national emission quotas to be eligible for trading. Inserting such a ceiling completely undermines the economic effect for which the original concept of trading aimed. The emergence of such a political difference severely undermines the tenuous consensus which underpinned the Protocol when it was completed. It is enough of a difference in its own right to put the Protocol in jeopardy. But even if this importance difference in approach had not emerged, there is a larger and much more fundamental flaw in the idea of a global emissions trading system. The ambition to set up such a system is utterly beyond the capacity of the world community to implement in the short and medium term.

Anybody who suggested the international community should establish a common global currency would be quickly besieged with a large number of convincing reasons why such an endeavour would be impossible to achieve. This would be in full knowledge of all the technical considerations which need to be known to achieve such a result. Establishing a global system of emissions trading would be much more difficult. First, it would require agreement on how the technical features of the global carbon cycle are measured. This is not known with sufficient exactness. There is no common scientific view on what controls the world volume of atmospheric carbon dioxide---is it burning of fossil fuel; expansion or reduction of forest sinks; clearing of land; atmospheric activity; interaction between the atmosphere and the oceans; or, if as is likely, a combination of all those things? We do not have a sufficient understanding of what the effect of each is, or whether we understand all of the mechanisms in play. If we cannot be technically precise about how the carbon cycle works, how can we devise a system to control it?

Second, it would require every country to agree on what the world stock of CO2 should be, and on what the share of that stock which each nation should enjoy. These are economic questions. Assigning common economic values to all those activities so that individual circumstances of each economy can be assessed, to determine what the quota for each country should be, is a politically impossible task.

The process would require trying to do what can never be done in market economies:- and that is to establish a standard value or price for an activity and to impose that price in every economy. Put simply, this is global command economics. The effort should not be made, not only because it is a bad idea, but because it could never be achieved. Even if the chance of securing an agreement on either a global price of CO2 emissions, or alternatively, a global cap on those emissions, was rated as achievable, it would take several decades to negotiate. Nothing on this scale has ever before been attempted. Consider the difficulties of trying to reach agreement on a common world currency, then multiply the difficulty of that by say one hundred fold. Why would anyone try?

The problem of the lack of universal application of the provisions of the Protocol is recognised by those who are working to make its provisions operational. They argue that the "Joint Implementation" procedure and the "Clean Development Mechanisms" will secure the commitment of the developing countries to the Protocol and substitute for the lack of formal obligation on them to set targets to reduce carbon emissions.

The idea seems to be that developing countries can be enticed with offers of investment and low cost loans to undertake projects through which they will reduce their carbon emissions. Such efforts might result in activities which produce less CO2 than might otherwise have been the case, but why should this result in the developing countries reducing their rates of production of CO2 to the extent necessary to reduce the predicted global temperature increases, when they have already refused to accept that they should do anything now?

It has not worked in any other sphere of international activity unless the payments are linked to binding commitments. But, as has already been stated, the developing countries are opposed to binding commitments.

It is hard to understand why officials, and trade and foreign ministries, who have spent years trying to negotiate international treaties, have chosen in the case of the Kyoto Protocol to cast aside their knowledge of the realities of the processes of multilateralism. Some them are worth recalling.

The Limits of Multilateralism

There appears to be a widespread belief that because Governments have supported, or said they will sign, the Kyoto Protocol, they will enact its provisions.

It is for some a disheartening reality that governments take a basically permissive attitude to what they call "political" commitments in the multilateral system. It is a simple matter to support resolutions and proposals for conventions which end genocide, tyranny, war, commit to allocate one percent of GDP to aid, or convey general commitments to political freedom, human rights and free trade, even if the actual proposals are impractical. Very few resolutions are voted down or even attract negative votes in the UN system. The vote is regarded as an indication of the political attitude of governments to the issue. If the proposal is regarded as impractical, the standard expression of opposition is to abstain.

The unwillingness to say "No" can create situations where political pressures can lead to concepts being supported and treaties being negotiated which never come into effect. A minor example is the Protocol to the Basle Convention on the Transboundary Movement of Hazardous Wastes which prohibits trade between industrialised and developing members of the Convention. This is a piece of economic madness(2) which nevertheless secured sufficient agreement to be opened for ratification. Excluding the EU and its member states, only a handful of countries have done so and there is no indication it will attract enough ratifications to come into effect. Nevertheless, an overwhelming majority of states assented to the text when it was negotiated.

There are more notable examples of this phenomenon. In the text of the Law of the Sea Convention there are provisions to create an International Seabed Authority and a Seabed Mining Enterprise, which were to be set up, respectively, to regulate and to mine mineral resources on the Seabed. They have never been activated, but many, many hundreds of staff-hours went into the negotiation of the provisions. It never was a practical idea. Nobody would dream today of putting forward such an idea.

For over a decade, there were negotiations over a Treaty to create a "Common Fund" to provide large-scale financial support to supplement the export income of commodity exporters, when prices of commodities fell on world markets. The amount of money required to bankroll such a scheme would have dwarfed the Australian budget outlays of the period. The provisions for the Common Fund exist in a Treaty which has been ratified. However, the only part of the Common Fund Agreement that has been enacted is a provision to provide technical assistance for some commodity producing countries. This is a minor activity. Most western governments solemnly went along with the Common Fund, although it is certain that their Treasuries and Finance Ministries never intended that funds would be provided for it.

It is common for governments today to sign international treaties on the basis that that is just a "political" commitment, that legal commitments do not have to contemplated until it is time to ratify the Treaty. To summarise the point, there is a dynamic in the multilateral system which periodically allows governments to overreach with political commitments, and then to pull back from real commitments when the momentum behind a particular issue has faded away.

This explains why governments sometimes commit to the terms of treaties which are basically unworkable. What do Governments do when they find themselves in such situations? There are several standard strategies. One is to let negotiations over implementation drag on and on until they simply slow to a halt and nothing happens. This was the result of the international negotiations in the late seventies to recycle the petro-dollars earned from the Arab oil price hikes, and the subsequent efforts in the United Nations to create new global mechanisms to establish "The New International Economic Order" and the "Global Negotiations" to institutionalise that Order.

A second strategy is to introduce new issues which represent a step back from the consensus which underpinned the original agreement. The decision by the EU to oppose a full global emissions trading system after going along with it when the Kyoto Protocol was negotiated can be seen in this light.

A third strategy is to convert the original treaty into something else. This is what happened with the Common Fund. It is the most likely direction in which the Kyoto Protocol will move once Governments conclude they cannot implement it. A practical version of the Treaty would be to turn it into a register of actions taken by states to reduce CO2 emissions. This would be far less than Greens wanted, but Governments usually devise some alternative, no matter how modest, when they are cornered for failing to deliver on a commitment.

The Implications of Australian Policy

Australia went to Kyoto with a complex position. It would go along with the Protocol only on certain conditions. It wanted the right to increase CO2 emissions before it reduced them, it wanted greenhouse controls to cover other gases than CO2, it wanted other contributors to rising greenhouse emissions such as land clearing included and it wanted the Protocol to include a system of global emissions trading. Australia got virtually everything it asked for, an outcome to which Stuart Eizenstat, the US lead negotiator at Kyoto, testified before a US Congressional committee in April 1998. Environmental groups thought the Australian demands were preposterous and anti-green, and tried to depict them as cheeky, if not outrageous, and far removed from the industrialised country environmental mainstream. They were surprised and angry that virtually all the Australian conditions were secured.

That Australia achieved these results would not have been seen as a surprise if the Kyoto Protocol was seen for what it was---a global effort to regulate production and consumption of energy. Australia is one of the world's major coal producers and is the world's largest exporter of coal. The Europeans knew a greenhouse treaty to regulate the production of CO2 would have been almost worthless without the world's biggest coal exporter, and major exporter of energy intensive products such as aluminium on board.(3) The political dimension was also important. If Australia had refused to agree to the Kyoto text, and had articulated cogent reasons for its refusal, the credibility of the outcome would have been severely diminished.

Australia left the Kyoto negotiations with another position. Australia would not be ratifying the Kyoto Protocol if the US did not. This was stated several times by Senator Hill, the Australian Environment Minister. The Coalition Government inherited another element of policy from its Labor predecessor. Australia would not go along with measures to reduce greenhouse gases if it reduced the international competitiveness of the Australian economy. This position was aggressively asserted in the lead up to Kyoto by Alexander Downer, the Foreign Minister and Tim Fischer the Trade Minister. Putting these positions together, Australia's policy could be summarised with the words, "we will, but only if you will".

This made great sense. Australia's fossil fuel resource is a great comparative advantage. Australia had become an efficient user of this advantage and it underpinned the strategy set in place by the Hawke Government to install global competitiveness in the Australian economy as part of the strategy to restore to Australia the comparative level of prosperity we used to enjoy before WWI, and in doing so, to reduce unemployment to post-WWII levels.

Since Kyoto, there is reason to conclude that Australia's approach to reducing global emissions has changed. The position was "we will, but only if you will". It has now become, "we are going to do it soon, because there is strategic advantage in adopting advanced emission control standards." There is not a statement by a government minister which says this, but there is an abundance of anecdotal evidence concerning comments by officials in public and private discussions, which demonstrate this is now the aim of government policy.

The Australian Greenhouse Office is developing policy in several directions. One is to set up a system of emissions trading in Australia. The general justification given is that this is to prepare Australia for the advent of the global emissions trading system. This is not logical. Since the prospect of an international system of emission trading is becoming less and less likely, why devote the resources and time to setting up a system of internal trading?

The second reason is that this will prepare Australia to meet its obligations to reduce emissions of CO2. Setting up a trading regime will be the means of taxing carbon to reduce burning of carbon, in particular burning carbon to generate electricity. If Australia is to use tax measures to reduce CO2 emissions, then the tax will have to be proportional to CO2 emissions. This means that the Victorian Latrobe Valley power generators which burn brown coal (generating high levels of CO2 per unit of output) will be taxed more than generators using black coal from the Hunter Valley. A domestic trading regime will achieve this result and do this in the name of economic efficiency.

The Greenhouse Office is energetically preparing for a carbon tax and a trading regime. Incredibly, correspondence from the Prime Minister, the Treasurer, the Minister for Industrial Relations, and various officials to concerned industry groups, repeatedly assert that adoption of a carbon tax is not Government policy. Either there is a considerable deceit in Government policy; or senior officials do not understand what the point is of a domestic emissions trading system; or they have not advised their ministers of the full implications of what is proposed.

The slippage that has taken place from the "we will, but only if you will" policy, means that a clear reaffirmation of this position by the Government is necessary. The Labor Opposition should also reaffirm the position it adopted under Hawke and Keating. The Minerals Council of Australia has tried several times to get a restatement by the Government of this policy without success. Increasingly the argument is being made that there is advantage for Australia in moving before others do, to reduce greenhouse emissions. Officials regularly refer to the new greenhouse growth industries that Australia can establish a new comparative advantage in, "on the ground floor". They are the traditional list---environmental engineering, waste management, the redoubtable solar heaters and, most fashionable of all, the imminent global market for permits to produce CO2.

It is now commonly asserted that a global market in emissions trading is just around the corner. Environmental consultants are encouraging companies to "invest" in things that will create trading rights---for example, tree plantations by power companies or automobile manufacturers. As noted above, the common value of what is to be traded is a very long way off from being determined. Potential investors would be wiser to invest in Czarist bonds or Weimar Republic Deutschemarks. At least they have the value of the paper they are printed on. No CO2 emission permit has such a recognised global value, nor will one do so for a very long time. One has to wonder if Australian environmental officials have fallen for the spin.

It is to be expected that officials in the environment ministry would argue for policy which accorded more with the policy lines prescribed the environment ministries in Europe. However if greenhouse policy moves away from "we will, but only if you will" position, this presages a major shift in policy in Australia on global commodity issues. Australia's natural resource endowment has always led it to follow a trade policy which has differed from other OECD economies. That is why Australia has been so unrelenting about agricultural trade reform. Its basic resource interests were not the same as those in Europe, Japan and in some sectors in the US. It was in Australia's national interest to adopt positions which vigorously advocated and advanced those policies.

If our position on greenhouse gives primacy to aligning our policies with those of Europe and Japan,---which is where Australian greenhouse policy is heading---then the effect will be similar in consequences to aligning our agricultural policy with that of Europe, except that energy replaces agriculture. The traditional interest of European nations on energy issues has been that of a consumer. There is a producer interest---with North Sea oil and gas which is relatively new---but this has had the effect of biasing European policy on energy away from coal.

The desire in the Government to set up policies to secure reductions of emissions of CO2 is not only going to reduce competitiveness in the Australian economy, it will lead to an historic change of direction in Australia's economic and trade policy away from policies which reflect and build on Australia's comparative advantage. This is a formula for impoverishment.

A Logical Australian Policy on Greenhouse Emissions

If there is a political requirement to take action to address the possibility of greenhouse warming in the absence of an adequate commitment by the global community to take effective political action, what would be an appropriate approach for Australia? It would be contrary to the national interest to reduce national economic well-being, when doing so would have no observable impact on the greenhouse problem.

An effective approach would be to fund projects which increased the efficiency of production of energy. This would result in reduction of generation of CO2 as a by-product and increase the global competitiveness of the global economy. If it were the case that ultimately the international community found a global strategy which was effective in reducing generation of CO2 Australia could easily accommodate to it. If the rest of the world took no action, Australian could be satisfied that it had pursued a course which reduced rates of generation of CO2 from power generation while others did nothing and had the added benefit of increasing the competitiveness of the Australian economy.

All this seems ridiculously simple. But the ridiculousness of it fades in the face of the madness of negating an important element in Australia's international competitiveness, and thus reducing our capacity to increase prosperity and reduce unemployment. The logic underpinning the current direction of policy is that this negation is going to be mandated in order to reduce our production of CO2, even though the rest of the world will not, and even though Australia's acting alone makes no discernible difference. And all because the real weakness of Kyoto is not understood---it is a chimera.

Endnotes

1. The US Senate has decided (95­0) that it will not approve a Protocol if the developing countries are not parties.

2. There is no economic feature in the recycling of the products covered by the Protocol which can distinguish the production or recycling of the product in developing countries as a group compared to industrialised economies as a group. Any division of economic activity between industrialised and developing economies is a political division. No serious trading country in the world, developed or developing, would agree to create trade restrictions on this basis in an international trade agreement. It would not be in any party's overall economic self interest.

3. Australia's success was not due just to the natural influence Australia's coal resources gave it. Multilateral diplomacy still requires exercise of all the skills to capitalise on comparative advantage. The Australian success in the negotiations was one of the greatest successes in the history of Australian multilateral diplomacy. It was due almost entirely the efforts of Meg McDonald, the Australian Ambassador for the Environment. She applied the skills she acquired as an Australian negotiator during the Uruguay Round, a high-point in the history of Australia's trade negotiations. The result stood in sharp contrast to the abject failure to secure recognition of Australia's agricultural export interests (Australia is one of the world's biggest exporters of wheat) in the negotiations over the Cartagena Protocol on trade in genetically modified products. By any measure, McDonnell's effort deserved recognition in the national honours. There was none. A common view in the Australian environmental policy establishment was that she had succeeded too well: Australian policy had not been Green enough. An unwritten policy goal of environmental official after Kyoto was to adopt even more Green positions in order to compensate for the excessive "brown-ness" of policy at the Kyoto conference.