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Euro Debt and Climate Crises Spotlight Free Riders

Collective action flounders on EU’s fast-moving debt crisis and world’s slow-moving climate change

By Scott Barrett Created: December 11, 2011 Last Updated: December 24, 2011
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An activist of British charity Oxfam pretends to eat a piece of coal as a protest aimed at the UN Framework Convention on Climate Change as she sits between bags reading 'Let Them Eat Carbon' on December 9, 2011 in Durban. (Stephane De Sakutin/AFP/Getty Images)

An activist of British charity Oxfam pretends to eat a piece of coal as a protest aimed at the UN Framework Convention on Climate Change as she sits between bags reading 'Let Them Eat Carbon' on December 9, 2011 in Durban. (Stephane De Sakutin/AFP/Getty Images)

NEW YORK: The spotlight on this year’s long-planned climate negotiations in Durban must be shared with the hastily arranged eurozone negotiations in Brussels. These issues seem a world apart, but the fast-moving euro crisis and the slow-moving climate crisis have similar origins. Addressing both require collective action.

In the case of the euro, the problem is that poor fiscal discipline by any euro country threatens other members. By unifying monetary policy but not fiscal policy, Europe created an incentive for the less disciplined countries to free ride on the members that held stronger credit ratings, helped along, perhaps, by expectations of a bailout.

There is a strong urge for countries to free ride. Globalization amplifies these incentives.

For climate change, the problem is that every country’s emissions of greenhouse gases add to atmospheric concentrations. The costs of reducing emissions are borne by the countries that take action. The benefits, by contrast, are diffused. There is a strong urge for countries to free ride. Globalization amplifies these incentives.

Toothless Policies

To prevent fiscal free riding, the eurozone created the Stability and Growth Pact in 1997. This required that government budget deficits not exceed 3 percent, and that government debt not exceed 60 percent, both relative to GDP. Stiff penalties were proposed, but by design their imposition was to be a political decision.

When, in 2003, the euro’s biggest economies, France and Germany, exceeded the 3 percent limit three years running, the threatened punishment was not imposed. This showed that the threat lacked credibility.

To prevent free riding in the abatement of emissions, the Kyoto Protocol was negotiated under the auspices of the United Nations. Kyoto was negotiated the same year as the Stability and Growth Pact in1997.

Unlike the caps imposed by the Stability and Growth Pact, Kyoto’s emission caps vary from country to country. They also apply over a period of five years, from 2008 to 2012. Though this period has yet to expire, Canada has already said that it won’t comply.

Kyoto requires that Canada cut its emissions 6 percent, but at last report in 2009, its emissions were up by 17 percent—a gap of 23 percent. Parties agreed on penalties for non-compliance, but did not adopt them by amendment. This makes Kyoto’s enforcement mechanism worse than non-credible; it makes it non-binding.

While international law says that countries must comply with their treaty obligations, countries are not obligated to participate in a treaty, and there is speculation that Canada will withdraw from Kyoto. Of course, the United States never ratified Kyoto.
The lesson is that an effective agreement must not only enforce compliance. It must also enforce participation.

The design problems with the Stability and Growth Pact were never remedied, and the meeting in Brussels sought to change that. Angela Merkel had proposed fiscal union with strict rules that would be enforced by the European Court of Justice, not politicians.

The “fiscal compact” just approved would enforce a breach of the same fiscal constraints written into the original Stability and Growth Pact, but only so long as sanctions proposed or recommended by the European Commission are not rejected by a qualified majority of euro members, leaving political wiggle room. Agreement by all 27 EU members could not be reached, but the governments of all eurozone countries support the new arrangement.

Bringing it into law, however, will be a long process, with profound political implications. Will parliaments agree to forfeit ability to set their own budgets? If the decision were put to a referendum, would voters approve? Finally, this agreement can only address the long-run problem of incentives. It does nothing to address the immediate problem of growth. Problems still lie ahead for the euro.

Future Consequences

A new climate agreement was supposed to be forged in Copenhagen two years ago, but that effort failed. Instead, a new approach emerged involving bottom-up, voluntary efforts. Developing countries had hoped to negotiate a successor to Kyoto, with legally binding obligations, this week in Durban. But key countries no longer support this approach. Today, an agreement on binding commitments seems most unlikely.

Notice the contrast between these two situations: The euro members are seeking to strengthen their treaty, while the parties to the Kyoto Protocol are moving to weaken theirs.

We shouldn’t be surprised. Of the two issues, climate change is much harder to address. However, it’s also more threatening in the long run.

The worst outcome for the euro is that the monetary union breaks up and its members revert to the situation that existed before—though partial breakup is more likely. This would be costly, but won’t cost any euro member much more to exit the euro than it did to enter it.

With climate change, by contrast, there’s no turning back. Atmospheric concentrations of greenhouse gases are rising every year. A significant portion will remain for thousands of years. From today’s perspective, this may seem unimportant. But temperatures respond slowly to rising concentrations. We have yet to see the consequences of Kyoto’s failure.

Climate change, as a global challenge, is harder to address. Free-rider incentives multiply as the number of countries seeking to cooperate increases. Institutions are also weaker at the global level. Enforcement must largely be internal to an agreement, whereas decisions by the European Court of Justice are binding. Of course, members may withdraw from the European Union, and so cease to be subject to the decisions by the European Court, just as parties may withdraw from a treaty. But withdrawal from the EU by any member would be more costly than withdrawal from a single treaty.

Some global agreements work wonderfully. The Montreal Protocol, adopted in 1987, has been remarkably effective in getting countries to reduce emissions of chemicals that destroy the ozone layer. It’s also an excellent climate agreement. By one estimate, Montreal has reduced greenhouse gas emissions four or five times as much as Kyoto aspired to achieve. Moreover, the United States, Canada and Mexico have proposed extending Montreal to phase down one of the greenhouse gases controlled by Kyoto – hydrofluorocarbons. Montreal works because it’s better designed than Kyoto.

However, it also works because reducing these emissions is easier than reducing carbon dioxide emissions. Montreal’s success cannot be replicated for climate change.
Another difference between the talks in Brussels and Durban is that the euro has reached a crisis moment, and climate change has not. As noted before, however, the climate responds slowly to rising concentrations of greenhouse gases—much more slowly than interest rates respond to debt levels.

Lack of an evident climate crisis today should provide no comfort. The future is uncertain, but it’s possible we will cross a dangerous tipping point with unpredictable, accelerating consequences. Just as the euro appeared stable a few years ago, so we may discover that Earth’s climate is more fragile than it appears today.

Scott Barrett is the Lenfest-Earth Institute Professor of Natural Resource Economics at SIPA and the Earth Institute. With permission from YaleGlobal Online. Copyright © 2011, Yale Center for the Study of Globalization, Yale University.




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