7.3 System Boundaries: Project, Sector, and Macro
Researchers make a distinction between project, sector, and economywide analyses.
Project level analysis considers a stand-alone investment assumed
to have insignificant secondary impacts on markets. Methods used for this level
include CBA, CEA, and life-cycle analysis. Sector level analysis examines sectoral
policies in a partial-equilibrium context in which all other variables
are assumed to be exogenous. Economy-wide analysis explores how policies affect
all sectors and markets, using various macroeconomic and general equilibrium
models. A trade-off exists between the level of detail in the assessment and
complexity of the system considered. This section presents some of the key assumptions
made in cost analysis.
A combination of different modelling approaches is required for an effective
assessment of climate change mitigation options. For example, detailed project
assessment has been combined with a more general analysis of sectoral impacts,
and macroeconomic carbon tax studies have been combined with the sectoral modelling
of larger technology investment programmes.
The baseline case, which by definition gives the emissions of GHGs in the absence
of the climate change interventions being considered, is critical to the assessment
of the costs of climate change mitigation. This is because the definition of
the baseline scenario determines the potential for future GHG emissions reduction,
as well as the costs of implementing these reduction policies. The baseline
scenario also has a number of important implicit assumptions about future economic
policies at the macroeconomic and sectoral levels, including sectoral structure,
resource intensity, prices, and thereby technology choice.
7.3.2 Consideration of No Regrets Options
No regrets options are by definition actions to reduce GHG emissions that have
negative net costs. Net costs are negative because these options generate direct
or indirect benefits, such as those resulting from reductions in market failures,
double dividends through revenue recycling and ancillary benefits, large enough
to offset the costs of implementing the options. The no regrets issue reflects
specific assumptions about the working and the efficiency of the economy, especially
the existence and stability of a social welfare function, based on a social
- Reduction of existing market or institutional failures and other barriers
that impede adoption of cost-effective emission reduction measures can lower
private costs compared to current practice. This can also reduce private costs
- A double dividend related to recycling of the revenue of carbon taxes in
such a way that it offsets distortionary taxes.
- Ancillary benefits and costs (or ancillary impacts), which can be synergies
or trade-offs in cases in which the reduction of GHG emissions has joint impacts
on other environmental policies (i.e., relating to local air pollution, urban
congestion, or land and natural resource degradation).
The existence of a no regrets potential implies that market and institutions
do not behave perfectly, because of market imperfections such as lack of information,
distorted price signals, lack of competition, and/or institutional failures
related to inadequate regulation, inadequate delineation of property rights,
distortion-inducing fiscal systems, and limited financial markets. Reduction
of market imperfections suggests it is possible to identify and implement policies
that can correct these market and institutional failures without incurring costs
larger than the benefits gained.
The potential for a double dividend arising from climate mitigation policies
was extensively studied during the 1990s. In addition to the primary aim of
improving the environment (the first dividend), such policies, if conducted
through revenue-raising instruments such as carbon taxes or auctioned emission
permits, yield a second dividend, which can be set against the gross costs of
these policies. All domestic GHG policies have an indirect economic cost from
the interactions of the policy instruments with the fiscal system, but in the
case of revenue-raising policies this cost is partly offset (or more than offset)
if, for example, the revenue is used to reduce existing distortionary taxes.
Whether these revenue-raising policies can reduce distortions in practice depends
on whether revenues can be recycled to tax reduction.
Ancillary Benefits and Costs (Ancillary Impacts)
The definition of ancillary impacts is given above. As noted there, these can
be positive as well as negative. It is important to recognize that gross and
net mitigation costs cannot be established as a simple summation of positive
and negative impacts, because the latter are interlinked in a very complex way.
Climate change mitigation costs (gross and well as net costs) are only valid
in relation to a comprehensive specific scenario and policy assumption structure.
The existence of no regrets potentials is a necessary, but not a sufficient,
condition for the potential implementation of these options. The actual implementation
also requires the development of a policy strategy that is complex as comprehensive
enough to address these market and institutional failures and barriers.
For a wide variety of options, the costs of mitigation depend on what regulatory
framework is adopted by national governments to reduce GHGs. In general, the
more flexibility the framework allows, the lower the costs of achieving a given
reduction. More flexibility and more trading partners can reduce costs. The
opposite is expected with inflexible rules and few trading partners. Flexibility
can be measured as the ability to reduce carbon emissions at the lowest cost,
either domestically or internationally.
7.3.4 Development, Equity, and Sustainability Issues
Climate change mitigation policies implemented at a national level will, in
most cases, have implications for short-term economic and social development,
local environmental quality, and intra-generational equity. Mitigation cost
assessments that follow this line can address these impacts on the basis of
a decision-making framework that includes a number of side-impacts to the GHG
emissions reduction policy objective. The goal of such an assessment is to inform
decision makers about how different policy objectives can be met efficiently,
given priorities of equity and other policy constraints (natural resources,
environmental objectives). A number of international studies have applied such
a broad decision-making framework to the assessment of development implications
of CDM projects.
There are a number of key linkages between mitigation costing issues and broader
development impacts of the policies, including macroeconomic impacts, employment
creation, inflation, the marginal costs of public funds, capital availability,
spillovers, and trade.