The Role of Financial Instruments in Solving the Global Climate Crisis

Abstract

Despite the accumulation of scientific evidence for an anthropogenic role in global warming, the response in terms of international action remains rather disappointing. The Kyoto Protocol failed to create an international coalition in favour of a carbon price in relation to its social cost and served to illustrate the intrinsic instability of any international effort which does not take the “free-rider” problem seriously. Any international agreement must meet three criteria: economic efficiency, incentives to meet commitments and equity. Efficiency is only possible if all countries apply the same carbon price. An incentive may entail offering some flexibility regarding “free riding.” Equity, a concept whose definition differs depending on the stakeholders involved, can be achieved through flat-rate transfers. The strategy of a voluntary reduction of carbon emissions, such as that adopted by key countries, is a further example of choosing to postpone clear commitment, while, in the meantime, paying insufficient attention to the financial instruments available.