samedi 22 mars 2008


24 International environmental cooperation: the role of political feasibility Camilla Bretteville Froyn:

1. Introduction1
Why is it so difficult to establish effective institutions for the provision of
global public goods? This chapter draws on contributions from game
theory and public choice theory to explore the obstacles to creating
effective institutions for the provision of public goods and how they might
be overcome. In particular, it focuses on how international and domestic
factors influence a country’s choice regarding co-operation and compliance
in international environmental agreements (IEAs).2
The chapter argues that the bottom line in international environmental
cooperation will always be determined by what is politically feasible.
Furthermore, since shared resources are prone to overuse when countries
pursue unilateral policies, and since the provision of global public goods will
have to rely on volunteerism, the aim of any IEA should be to ensure par-
ticipation and compliance. It argues further that this can best be achieved
by restructuring the relationships among countries in a mutually preferred
way, taking into account the complexity of a country’s negotiating position
that results from the influence of different domestic constituencies with a
stake in environmental policy.
Game theory is concerned with the strategic actions of different players
(consumers, firms, governments, and so on) where these actions are in some
way interlinked. This could for example be firms interacting in an emissions
permit market or governments negotiating reductions in greenhouse gas
emissions. The fundamental assumption is that players choose their
strategies based on the beliefs they have regarding the choices of other
players. Game theory provides tools for increased understanding of
what drives the results in international co-operation.3 The public choice lit-
erature analyzes how decisions are made by governments, focusing on how
political agents motivated by self-interest seek to sway public policies. Public
choice theory suggests that a proper understanding of institutional settings
allows relatively straightforward net-benefit maximizing models to account
for a rich and complex range of policy outcomes (Congleton, 2004), includ-
ing government negotiating positions in international forums.4, 5
The next section provides a brief explanation for the need for IEAs,
while section 3 gives a theoretical argument for why optimal levels of co-
operation are so hard to achieve. The following three sections focus on ways
to increase co-operation: the prevention of free-riding (section 4); a closer
look at self-enforcing environmental agreements (section 5); and multiple
agreements (section 6). Section 7 argues that it is important to take into
account that a country’s negotiating position is a result of bargains struck
among different domestic interest groups. Concluding remarks are offered
in the last section.
2. The need for international environmental agreements
IEAs offer issue-specific remedies for almost every kind of international
environmental problem (Barrett, 2003). They establish institutions for con-
serving threatened species, unique ecosystems, and sites of cultural heritage;
for controlling pests and plagues; for reducing pollution; for safeguarding
workers from toxic substances; for protecting animals from inhumane
farming practices; for promoting the conservation of tropical forests; for
controlling desertification; for banning nuclear weapons testing; and much
more.6 Some IEAs work quite effectively, such as the Montreal Protocol,
which regulates emissions of substances that deplete the ozone layer, but
many are weak and ineffectual.
The need for international environmental co-operation is linked to
market failures in which participants’ self-interested actions do not achieve
an efficient outcome so that it is possible to increase the welfare of one or
more individuals without harming the welfare of someone else. When
market failures exist, social welfare may be increased by intervening in the
market.7 Market failures can result from externalities, which are inter-
dependencies among two or more countries not taken into account by
market transactions.8 One example is transborder pollution: if the emitting
country is not required to compensate the downwind country (or coun-
tries), then the emitter would have no incentive to curb its polluting activ-
ity. From a social welfare perspective, too much production is taking place
unless the externality-imposed costs are included in the producer’s produc-
tion costs. When market failures are of an international character there is
no world government that can intervene, but agreements constitute an
alternative form of ‘intervention’. At the international level, externalities
require bilateral or multilateral agreements.
Another source of market failure is public goods. For international
public goods, the benefits are shared by countries in a non-exclusive and
non-rival manner. This means that the benefits from the public good can be
received by payers and non-payers alike, and that one country’s consump-
tion of the good does not affect the consumption possibilities of other countries. Thus each country would be better off if all countries contribute
to the provision of the public good, but each country is still better off if it
can free-ride on the other country’s contributions.9 International public
goods can be bilateral (for example, reducing mercury discharges that affect
two countries), regional (for example, reducing sulfur dioxide emissions in
Europe), or global (for example, protection of the ozone shield, protection
of biodiversity, or the reduction of greenhouse gases to prevent global
warming). This chapter focuses mainly on international co-operation for
the provision of global environmental public goods.10
The characteristics of global public goods give rise to collective provision
issues that are difficult to overcome, and make the need for international
institutions substantial. For the purposes of this chapter, an institution is
defined as a persistent and connected set of rules that prescribe behavioral
roles, constrain activity, and shape expectations.11 The rules of any institu-
tion, however, will reflect the relative position of its actual and potential
members (Keohane, 1989). Rules also determine the type of institution that
will develop, who will benefit, and how effective it will be. In the develop-
ment of such international institutions, countries are like game players that
must choose their strategies based on their beliefs about the likely choices
of others. The existence of international regimes will, thus, not ensure
optimal levels of cooperation. Failure to solve the problem of providing
international public goods is well known, and an institution’s level of
success will depend on the different country’s response to the agreed-upon
set of rules (the design).
3. The law of the least ambitious program
The law of the least ambitious program: Where international management
can be established only through agreement among all significant parties
involved, and where such a regulation is considered only on its own merits,
collective action will be limited to those measures acceptable to the least
enthusiastic party (Underdal, 1980, p. 36).
The public goods problem of under-provision is particularly challenging
on a global scale because there is no supranational authority to enforce an
agreement. In the absence of such an authority, alternative arrangements
are needed. The process of treaty-making, however, is complex and deter-
mines the quality of the outcome. A number of problems with global en-
vironmental protection have not been satisfactorily resolved through
international institutions. One well-known example is fisheries, which
experts for years have said have been over-fished because they have not been
sufficiently regulated through international agreements. Another example
is the lack of protection of tropical forests that provide public goods to the
global economy through benefits from biodiversity, ecosystem linkages and carbon sequestration. The law of the least ambitious program blames this
shortcoming on the unanimity rule by pointing out that it invariably places
the final word with the parties who are dragging their feet.12
The law of the least ambitious program has a strong intuitive appeal, and
offers some very basic and important insights in international cooperation
(Hovi and Sprinz, 2006). What it basically says is that as long as all parties
involved have to agree on the sets of rules that form the institution, the pre-
scription of behavioral roles and constraints on activity will not be stricter
than what is acceptable to the least ambitious.13 The reason is simply that
the least ambitious will suffer the smallest loss should the negotiations
break down. This gives them bargaining power, and they will thus tend not
to give in. The other countries, on the other hand, could choose to dump
the least enthusiastic party, rather than to give in, but at a price: they could
then negotiate a more potent, but incomplete, treaty.14
The most well-known example might be the international climate nego-
tiations. The Kyoto Protocol, as agreed to in 1997,15 was merely a sketch of
an institution, and it took several years of tough negotiations to agree on
the specific rules of conduct.16 Compared to the original expectations of
the Kyoto Protocol, the final climate treaty was a compromise and signifi-
cantly watered down. The main reason for this is the minimum participa-
tion rule.17 The US withdrawal from the climate negotiations in March
2001 gave the supporters of soft rules additional bargaining power. These
parties clearly held the most rigid positions in the negotiating process, not
willing to give much to reach agreement. However, the parties supporting
strict rules, that is, the most ambitious, seemed to want the Kyoto Protocol
to survive badly enough to place the final word with the ones in favor of
soft rules (Froyn, 2001). In the end they had to give in on all areas in order
to save the Kyoto Protocol,18 which entered into force on 16 February, 2005,
after 81 countries had ratified the treaty.19
As this example points out, the existence of international regimes
will not ensure that countries will be able to achieve optimal levels of co-
operation. For global public goods provision, the incentive for nations to
free-ride and the costs of detecting and punishing such behavior will be
greater the larger the number of countries.20 Institutions must therefore be
designed to reduce these incentives.
4. Preventing free-riding in international environmental co-operation
IEAs are established in an attempt to provide international public goods
and resolve environmental externalities among government jurisdictions.
The political and institutional problems that have to be overcome are there-
fore complex. Even if policy-making authority is delegated to an interna-
tional commission, or a treaty provides incentives to participate, state sovereignty implies that domestic legislation remains the method by which
such international environmental policies are implemented. Multilateral
solutions to environmental problems are therefore clearly more challenging
to achieve than solutions to domestic environmental problems.21 Those
challenges seem likely to linger as long as nations remain sovereign
(Congleton, 2001). Since a country is likely to participate in institutions –
such as the Kyoto Protocol – only when co-operation is associated with an
individual net gain (Svendsen, 2003; Underdal, 1998),22 the provision of
global public goods must rely on some kind of volunteerism. The only way
to deal with the free-rider problem is thus to restructure the underlying
incentives, such that it is in the countries’ best interest to both participate
and comply, and this should be the primary aim of any environmental
treaty (Barrett, 2003; Barrett and Stavins, 2003). How this can be done is
discussed below.
In the considerable body of literature that addresses the under-provision of
global public goods, a main problem analyzed is free-riding. When potential
ratifiers are uncertain about the actions of others, each country must anti-
cipate the probability of other countries not cooperating.23 Distrust is rele-
vant whenever some parties have, or might have, an incentive to free-ride.
There are two types of incentives for free-riding: the incentive for a country
not to sign an IEA and thus benefit from the signatories’ abatement efforts
(non-participation), and the incentive for a signatory to violate its commit-
ments in an agreement (non-compliance) (Finus, 2001). Participation and
compliance are joint problems, but they have often been analyzed sep-
arately.24 A country can avoid complying with a treaty by simply not partic-
ipating in the first place, and non-participation is the biggest credible
deviation a single country can carry out. Indeed, to the extent that abiding
by the commitments of an international treaty will result in a net loss, a ratio-
nal decision-maker will avoid implementing a policy to comply (Underdal,
1998). Deterring free-rider behavior, however, requires sacrifices by others,
and larger sacrifices are less credible because they are more self-damaging
(Barrett, 2003; Barrett and Stavins, 2003). The creation of incentive mech-
anisms to ensure participation and compliance is thus a major challenge for
parties in negotiations on IEAs.
Nevertheless, a remarkably small number of treaties include enforcement
mechanisms (Barrett, 2003). The current climate regime, as specified by the
final version of the Kyoto Protocol,25 however, is an exception. But even
though the Marrakesh Accords provide details for a compliance mech-
anism,26 it has been pointed out that the current design suffers from a
number of weaknesses (cf, Barrett, 2002; 2003; Hagem et al., 2005; Hagen and Westskog, 2005).27 It is therefore not likely that the Kyoto Protocol’s
enforcement mechanism will be able to ensure that ratifying countries fulfill
their obligations. Hence, external means of enforcement are potentially
required as an alternative – or a supplement – to the provisions of the
Marrakesh Accords.28 This can be achieved, for example, by linking envir-
onmental negotiations to other economic issues.
Issue linkage
One suggested solution to offset countries’ free-riding incentives is the
linkage of environmental negotiations to other economic issues (issue
linkage). The idea is to link an issue with excludable benefits (a club good)
to the public good provision. Compared to the stand-alone environmental
agreement, an agreement with this type of issue linkage ensures that the
benefit–cost ratio for accession is increased, and participation is thus more
attractive (Barrett, 2003). Suggestions include linking the climate change
regime with the international trade regime (Barrett, 1997; 2003) by, for
example, incorporating trade sanctions as a means of enforcement; or with
research and development (R&D) cooperation, by excluding non-parties
from enjoying the fruits of cooperative R&D (Barrett, 2003; Carraro and
Siniscalco, 1995; 1997).29
It is not always the case, however, that issue linkage helps international
cooperation. The effect depends on the issues that are linked and on how they
are linked. Murdoch et al. (1997) argues for instance that, had the Convention
on Long-Range Transboundary Air Pollution (CLRTAP) not provided for
separate protocols to be negotiated for each of the different pollutants, the
outcome of the negotiations would have given smaller reductions in sulfur
emissions.30 Thus, issue linkage can hinder as well as aid co-operation.
Side payments
Another theoretic solution to the free-rider problem is international trans-
fers or side payments. Transfers may be needed to make co-operation
individually attractive in asymmetric settings, that is, when the benefits
from and/or costs of co-operation differ across countries. The basic idea is
to redistribute the surplus to be gained from co-operation to compensate
the countries that would otherwise have chosen the non-co-operative
outcome.31 Some countries are affected more than others (in absolute or
relative terms) by an environmental problem. The asymmetries often dom-
inate negotiations, and are often perceived to be a main reason for why
agreement is so hard to achieve. Barrett (2003), however, shows that side
payments (or carrots) can promote co-operation, but only when countries
are sufficiently asymmetric, and when the side payments are combined with
credible threats of punishment (sticks).
The side payment solution might be difficult to implement in the case of
a long-term problem like climate change. Simulation models for climate
change mitigation have shown that, in the long run, the gains from co-
operation will more than compensate for the initial losses due to abatement
efforts. However, the fact that the expected break-even date lies very far into
the future complicates the side payment solution because the countries
cannot borrow against future gains in order to compensate for early losses,
although these kinds of distribution problems might be solvable through
some kind of banking system.32 Side payments are not often observed, at
least not in monetary terms, but one recent example is that the EU
promised to support Russia for membership in the WTO in order to per-
suade the Russian government to ratify the Kyoto treaty.
5. Self-enforcing environmental agreements: a closer look
The structure and characteristics of IEAs will have a significant influence
on the effectiveness as well as the costs and benefits of mitigation. The
effectiveness and the costs and benefits of an international regime (such as
the Kyoto Protocol or other possible future environmental agreements)
depend on the number of signatories to the agreement and their abatement
targets and/or policy commitments (IPCC, 2001).
A main strand of the literature on international environmental co-
operation focuses on the conditions for the formation of multilateral agree-
ments (or coalitions) in game theoretic settings. The fundamental
assumption is that international agreements must be self-enforcing since
there is no supranational authority that can enforce compliance. Notable
examples are Asheim et al. (2006), Barrett (1994; 1997; 1999), Carraro and
Siniscalco (1992; 1993), Hoel (1992), and Tulkens (1979). The assumption
of self-enforcement implies that optimal co-operation can only be sustained
by an international treaty if no country can gain by not being a party to it,
and no party can gain by not implementing it. An agreement must therefore
specify a strategy that, if obeyed, must succeed in deterring free-riding and
enforcing compliance. A strategy is credible if no country is worse off
accepting the agreement (individual rationality) and no sub-coalition of two
or more countries can achieve a higher joint payoff by concluding a partial
agreement (collective rationality). Furthermore, collective rationality
implies that an equilibrium agreement must be renegotiation proof,
meaning that it must be in the (collective) best interest of other countries to
insist that a non-compliant country be punished before co-operation can be
resumed (Barrett, 1999; 2003; Finus, 2001).
International environmental agreement models differ with respect to the
specification of the utility functions of governments and the stability
concept they employ. However, they can roughly be divided into two groups – dynamic game models and reduced-stage game models (Finus and
Rundshagen, 2003).
The dynamic game models typically assume an infinitely repeated game
where governments agree on a contract in the first period that has to be
enforced in subsequent periods by using credible threats (for example
Barrett, 1994; 1999). Studies using these models have found that a global
treaty typically will achieve very little and at worst not enter into force, and
that an incomplete treaty (a sub-coalition) may achieve more than the
global treaty. The reason for these results is that the larger the number of
parties to an agreement (k), the greater the harm suffered by the (k-1) other
countries when they impose the punishment needed to deter a unilateral
deviation, and consequently the less credible the threat.
Barrett (2002), shows that a single treaty can be broadened to incorpo-
rate all countries (a consensus treaty), but at the cost of limiting the
per-country level (the ‘depth’) of co-operation. He shows that countries can
reach agreement around a weak treaty, or they can negotiate a more potent
but incomplete treaty. Thus, when the constraint of self-enforcement binds,
we cannot have it both ways. Something has to give. Either participation
must be less than full, or signatories must choose abatement levels that fall
short of maximizing their collective payoff (Barrett, 2003). Allowing the
depth of cooperation to vary, Barrett (2002) demonstrates that countries
might prefer a ‘broad but shallow’ treaty over one that is ‘narrow but deep’.
Reduced-stage game models depict coalition (or treaty) formation as a
two-stage game. In the first stage, countries decide on the coalition forma-
tion. In the second stage, they choose abatement levels and how the gains
from co-operation will be distributed (for example Chandler and Tulkens,
1992; Carraro and Siniscalco, 1993; Hoel, 1992). Some of these models
define equilibria with both internal stability, meaning that no signatory has
an incentive to leave the coalition, and external stability, meaning that no
non-signatory wants to accede to the agreement. A key result is that the
number of signatories generally falls short of the complete coalition (the
global treaty): often, the equilibrium coalition is rather small. A second
result is that the coalition typically achieves results far from the social
optimum.33, 34
There are several important lessons to be learned from these game the-
oretic models. One is that if an international treaty, like the Kyoto Protocol,
sustains full compliance, the reason is that the agreement achieves very
little. Another is that even though the Kyoto Protocol is only a first step, if
the subsequent stages in the process replicate the Kyoto formula, the
outcome is likely to continue to be very close to ‘business as usual’. A third
is that a more ambitious future version of the current climate regime would,
on the other hand, most likely either fail to enter into force or fail to sustain full compliance. Moreover, since many of the proposals for alternatives to
the Kyoto Protocol also do not address the fundamental issues of enforce-
ment and participation, they too are likely to fail (Barrett, 2001). This does
not, however, imply that negotiation is a hopeless waste of time, but rather
that the current design of the Kyoto Protocol does not restructure the game
of climate change mitigation in a way that provides the supporting incen-
tives needed to effect a change in behavior over time.35
6. Multiple agreements
In an effort to increase participation, a few contributions have addressed
the possibility of giving countries the freedom to negotiate more than one
agreement. Bloch (1997), Carraro (1998; 1999; 2000), and Carraro and
Siniscalco (1998) provide examples with the use of reduced-stage game
models. A two-stage coalition game is used to show that when more than
one coalition is possible, the equilibrium coalition structure that endoge-
nously emerges from the negotiation process is characterized by several
coalitions. It has also been shown, in this setting, that social welfare can be
higher with multiple agreements than with a single global accord due to
increased total abatement (Carraro, 2000).
The question of more than one agreement is analyzed in an infinitely
repeated game framework in Asheim et al. (2006). Using a simple dynamic
model, with weak renegotiation-proofness as solution concept,36 they
demonstrate that two agreements can sustain a larger number of co-
operating parties than a single global treaty. They also show that a regime
based on multiple agreements can Pareto dominate a single agreement
regime. The results support the conclusions reached by Carraro and others
(for example Carraro, 1999; 2000 and Carraro and Siniscalco, 1998) using
a reduced-stage game framework.
An important driving force in infinitely repeated games is the way in
which the agreements are enforced. In the global treaty regime of Barrett
(1999) and Asheim et al. (2006), a single deviation triggers punishment by
all other parties. This drives the number of participating countries down
via the renegotiation-proofness requirement.37 If not all participating
countries punish a deviator, then more than one country will cooperate in
the punishment phase, and the renegotiation-proofness requirement is less
strict. This admits a larger number of participating countries. In the two
treaty regime in Asheim et al. (2006), participation is broadened because a
deviation triggers punishment by all parties in the deviator’s treaty, but not
by the countries that are parties to the other treaty.38, 39
If a regime with multiple treaties is to be negotiated, one would need a
criterion to decide what countries to include in which agreement. One
appealing criterion might be geographical region, although other criteria are certainly also conceivable. A regime with regional agreements may, for
example, facilitate external enforcement better than a regime with one
global agreement, because countries in the same region tend to be highly
integrated. A high level of interdependence implies that a host of options
are available (via issue linkages) for providing responses to non-compliance
in any one particular issue area. In addition, countries that are in close
geographic proximity also tend to be culturally close, have similar economic
and political systems, and therefore have similar preferences.40 All of this
might lower the costs of reaching agreement in the first place. Countries
may thus both be more likely to comply with a regional agreement and
more inclined to join a regional agreement in the first place (Asheim et al.,
2006). All of these features represent a potential rationale for regional
agreements, and could make such a regime an attractive option for
example in the negotiations on future commitment periods under the
Kyoto Protocol.
7. Interest group influence
Environmental policies influence a country’s economy in a number of
different ways, and the design of such policies is thus of great concern to a
number of groups. The influence of interest groups is therefore a reoccur-
ring theme in the study of environmental politics. One of the early classics
in the public choice literature is Mancur Olson’s (1965) The Logic of
Collective Action. In this book he applies public choice reasoning to the
analysis of various collective-action problems involving interest groups.
Interest groups have been a focal point within the public choice literature
ever since.
When arguing that government intervention is needed to correct market
failures when public goods, externalities and other sorts of market failures
are present, the economics literature often makes the implicit assumption
that these failures can be corrected at zero cost. The government is seen as
an omniscient, benevolent institution that dictates policies in order to
achieve a Pareto-optimal allocation of resources. The public choice litera-
ture challenges this utopia model of government by examining not how
governments may or ought to behave, but how they do behave. It reveals that
governments, too, can fail in certain ways.
Public choice argues that if the state exists in part to provide public goods
and eliminate externalities, then it must accomplish the same preference
revelation task for these public goods as the market achieves for private
goods. The public choice approach to non-market decision-making has
been (1) to make the same behavioral assumptions as general economics
(rational, utilitarian individuals), (2) often to depict the preference revela-
tion process as analogous to the market (voters engage in exchange, individuals reveal their demand schedules via voting, citizens exit and enter
clubs), and (3) to ask the same questions as traditional price theory: Do
equilibria exist? Are they stable? Are they Pareto efficient? How are they
obtained? (Müller, 2003).
Formally, public choice can be defined as the economic study of non-
market decision-making, or simply the application of economics to polit-
ical science. The subject matter of public choice is that of political science:
the theory of the state, voting rules, voter behavior, party politics, the
bureaucracy, public goods, and so on. The basic behavioral postulate of
public choice, however, is as for economics: that people are egoistic, ratio-
nal, utility-maximizers (Müller, 2003). It is assumed that each agent acts
optimally towards his preferences. However, the preferences regarding, for
example, environmental policies differ according to who or what the agent
is. While a firm strives to maximize profit, for example, politicians seek to
maximize influence and power (Svendsen, 1998). With this rational behav-
ioral assumption, the public choice approach is able to deliver clear-cut
predictions and simplicity, which makes it very user-friendly. However,
preferences might not be as stable as the theory predicts, making it less
applicable in practice. Norms and values, which are changeable, could
influence the cost–benefit analyses behind decisions (Krogstrup and
Svendsen, 2004).41
In an open society, environmentalist groups and their opponents, gener-
ally the corporations and businesses that resist the costs involved in com-
plying with environmental regulation, are presumed to spend resources on
trying to influence policy makers. The policy makers need the votes, the
money, the moral approbation, and the publicity these groups might
provide in exchange for policy stances that gain approval and avoid disap-
proval. Environmental policy is thus a function of the different pressures
emanating from these (and other) interest groups, and hence seldom fully
reflects the interests of any one of them (Barkdull and Harris, 2002). In
public choice theory, it is assumed that the direction in which these interest
groups will try to push the policy choice will depend on the distribution of
costs and benefits from regulation (Müller, 2003; Svendsen, 1998). A proper
understanding of institutional settings thus allows relatively straightfor-
ward net-benefit maximizing models to account for a rich and complex
range of policy outcomes (Congleton, 2004), including government nego-
tiating positions in international forums.
A country’s environmental foreign policy is presumed to be the outcome
of bargains struck among different constituencies with a stake in environ-
mental policy (Barkdull and Harris, 2002). Somehow the preferences of a
country’s citizens must be consolidated into a unitary negotiating position.
At the federal government level in the United States, for example, this requires resolution of conflicting positions taken by different executive
branch departments by means of inter-agency bargaining. For wide-
ranging issues like global warming, a dozen or more government agencies
may be involved that, in turn, represent a variety of interests. Each agency’s
negotiating position is thus influenced by lobby groups such as trade asso-
ciations, industries, and environmental and other non-governmental
organizations. The internal negotiations are thus very complex, and after
finally agreeing on what the country’s interests are, the official delegation
must negotiate with delegations from other countries.
Explaining a given environmental foreign policy, a county’s position in
international negotiations, or the overall character of a country’s policy
direction therefore requires identifying the groups that participate, their
relative influence, and the strategy and tactics they employ. Because of the
economic implications of environmental policy, elites take a strong interest
in this issue area and usually attempt to direct the government towards poli-
cies compatible with corporate freedom and economic growth (Bang, 2004;
Barkdull and Harris, 2002).42
8. Concluding remarks
The bottom line in international environmental cooperation will always be
determined by what is politically feasible. Because of the multiplicity of
decision-makers, ranging from the international governmental level down
to the micro level of firms and individuals, it is very hard to find strategies
for global environmental protection that are acceptable to all. Therefore, it
is also hard for a country’s government to choose a position in international
negotiations. In combination with the fact that environmental policies
cannot be isolated from other socio-economic goals, this multiplicity makes
negotiations on international environmental cooperation particularly com-
plicated. Domestic interest conflicts are thus among the biggest obstacles
to achieving a common political strategy for the protection of the global
environment. Another is the free-rider issue.
The economics literature has focused very much on optimal solutions
and cost-effectiveness. These are important issues, but optimal solutions
are less appealing if they are not politically feasible. The primary concern
for international environmental protection should rather lie with increas-
ing cooperation. The level of co-operation is to a large degree defined by
participation and compliance. Although countries might be less likely to
participate in and comply with treaties that are excessively costly, cost-
effectiveness is neither a necessary nor a sufficient condition for participa-
tion and compliance (Barrett, 2003).
The world’s level of protection of the global environment plays for all
intents and purposes no small part in determining whether the world is on a sustainable path, since shared resources are prone to overuse when coun-
tries pursue unilateral policies. Because the provision of global public
goods relies on volunteerism, the only way to beat the free-rider issue is to
restructure the underlying incentives. A central challenge of international
co-operation is thus to figure out how the relationships among countries
can be restructured in a mutually preferred way. According to Barrett
(2003), five tasks are necessary to achieve this: first, to create an aggregated
gain, that is, a reason for all countries to come to the bargaining table;
second, to distribute this gain such that all countries would prefer that the
agreement succeed; third, to ensure that each country would lose by not
participating, given that all the others agree to participate; fourth, to
provide incentives for all parties to comply with the treaty; and fifth, to
deter entry by third parties.
The outcome of an institution will always depend on the responses of the
different countries to the agreed-upon set of rules. A sixth task that should
be added is therefore the necessity of taking into account the complexity of
a country’s negotiating position resulting from different domestic con-
stituencies with a stake in environmental policy. Thus, to achieve higher
levels of provision of global environmental public goods, incentive restruc-
turing to achieve political feasibility, not optimality or cost-effectiveness,
should be the primary focus in the negotiations on any international envir-
onmental treaty.

25 Trade and sustainable development Kevin P. Gallagher :

1. Introduction
The world community faces the enormous challenge of the need to increase
the well-being of more than half its inhabitants without jeopardizing the
ability of the natural environment to function now and into the future – the
challenge of sustainable development. The recent wave of globalization in
the world offers an opportunity to meet that challenge. However, there is
increasing concern that the current form of globalization is at odds with
sustainable development.
Although the last decades of the twentieth century ushered an unprece-
dented level of international trade and investment, poverty and inequality
remain key characteristics of the global economy in the twenty-first
century. The World Bank defines poverty as those persons who earn less
than $2 per day (1999 purchasing power parity) and extreme poverty as
those who earn less than $1. Using this definition, about half of the world’s
population are poor, almost 3 billion people. Close to half of the poor live
in extreme poverty, 1.4 billion (Cline, 2004).
The world’s ecosystems fare no better. According to the recent
Millennium Ecosystem report conducted by 1300 experts from 95 coun-
tries, ‘60 percent of the ecosystem services that support life on Earth – such
as fresh water, capture fisheries, air and water regulation, and the regula-
tion of regional climate, natural hazards and pests – are being degraded or
used unsustainably’ (UNDP, 2005). Such degradation is proving to be
costly in economic terms. The World Bank and other international agencies
estimate that the economic costs of environmental degradation range from
6 to 10 per cent of GDP on an annual basis (Gallagher, 2004).
The speed and distribution of these changes are too fast for many people
to comprehend and accept. An escalating series of protests is occurring at
nearly every major meeting surrounding global economic affairs: the
WTO meeting in Seattle in 1999, the Washington IMF/World Bank
meetings in the spring of 2000, the July 2001 G-8 meeting in Geneva, the
Summit of the Americas meeting in Quebec in April 2001, the WTO
meetings in Cancun in 2003 and so forth. These events are paralleled by
similar protests in capitals across the globe. The protests outside the
meetings, and the increasing levels of disagreement among nations them-
selves, illustrate the breadth and depth of concerns of a growing but ill-defined constituency about the potential impacts of an unfettered
global marketplace.
With this concern in mind the world community has reasserted the need
for development through the Millennium Development Goals and the
global commitment to sustainable development signed at the World Summit
for Sustainable Development. At the same time, most of the world’s nations
have also embarked on a new round of global trade negotiations – the
so-called Doha Round under the World Trade Organization (WTO). The
Doha Declaration makes explicit reference to sustainable development:
We strongly reaffirm our commitment to the objective of sustainable develop-
ment, as stated in the Preamble to the Marrakesh Agreement. We are convinced
that the aims of upholding and safeguarding an open and non-discriminatory
multilateral trading system, and acting for the protection of the environment
and the promotion of sustainable development can and must be mutually sup-
portive. (WTO, 2001)
This chapter outlines the relationship between international trade and
sustainable development. It is organized into three parts. The first discusses
the theoretical relationships between these two phenomena, the second
examines the empirical evidence, and policy considerations conclude the
2. Trade and sustainable development: theory
In theory international trade and sustainable development can be mutually
compatible, and perhaps even reinforcing. According to independent the-
ories of international trade on the one hand, and environmental econom-
ics on the other, trade liberalization can bring economic benefits that can
be distributed in a manner to reduce poverty and protect the environment.
The economist David Ricardo showed that because countries face
different costs to produce the same product, if each country produces, and
then exports, the goods for which it has comparatively lower costs, then
all parties benefit. The effects of comparative advantage (as Ricardo’s
notion became called) on factors of production were developed in the
‘Heckscher–Ohlin’ model. This model assumes that in all countries there is
perfect competition, technology is constant and readily available, there is
the same mix of goods and services, and that factors of production (such
as capital and labor) can freely move between industries.
Within this rubric, the Stolper–Samuelson theorem adds that interna-
tional trade can increase the price of products (and therefore the welfare)
in which a country has a comparative advantage. In terms of foreign direct
investment (FDI), FDI can contribute to development by increasing
employment and by human capital and technological ‘spillovers’ where foreign presence crowds in new technology and investment. In theory, the
gains from trade accruing to ‘winning’ sectors freed to exploit their com-
parative advantages have the (Pareto) possibility to compensate the ‘losers’
of trade liberalization. Moreover, if the net gains from trade are positive
there are more funds available to stimulate growth and reduce poverty. In a
perfect world then, free trade and increasing exports could indeed be
unequivocally beneficial to all parties.
These theories have been extended to conceptualize the trade and envir-
onment relationship. A useful framework for thinking about trade and the
environment has been proposed by Gene Grossman and Alan Krueger
(1993). They identify three mechanisms by which trade and investment lib-
eralization affect the environment: scale, composition, and technique effects
(see also Chapter 15). Scale effects occur when liberalization causes an
expansion of economic activity. If the nature of that activity is unchanged
but the scale is growing, then pollution and resource depletion will increase
along with output. Composition effects occur when increased trade leads
nations to specialize in the sectors where they enjoy a comparative advantage.
When comparative advantage is derived from differences in environmen-
tal stringency then the composition effect of trade will exacerbate existing
environmental problems in the countries with relatively lax regulations.
Race-to-the-bottom discussions are perfectly plausible in economic theory.
The Hecksher–Ohlin (H–O) theory in trade economics postulates that
nations will gain a comparative advantage in those industries where they
are factor-abundant. Applying the H–O theory to pollution then, it could
be argued that a country with less stringent environmental standards would
be factor-abundant in the ability to pollute. Therefore, trade liberalization
between a developed and a developing nation where the developed nation
has more stringent regulations may lead to an expansion in pollution-
intensive economic activity in the developing country with the lesser regu-
lations. The developing country with the less stringent regulations becomes
a ‘pollution haven’ for pollution-intensive economic activity (Copeland and
Taylor, 2003).
Technique effects, or changes in resource extraction and production tech-
nologies, can potentially lead to a decline in pollution per unit of output
for two reasons. First, the liberalization of trade and investment may
encourage multinational corporations to transfer cleaner technologies to
developing countries. Second, if economic liberalization increases income
levels, the newly affluent citizens may demand a cleaner environment.
The economic and environmental dimensions of trade and sustainable
development are outlined in Table 25.1. The first column exhibits the
‘winners’ and ‘losers’ of trade liberalization. The second column outlines
the economic dimensions, the third outlines the environmental dimensions.
From an economic perspective, when liberalization occurs and nations
trade where they have a comparative advantage the ‘winners’ are those
sectors which can now export more of their goods or services. Theoretically
this will not only cause expansion of exports but also of employment and
wages in such sectors as well. The ‘losers’ of the liberalization are those
sectors that will find it harder to face an inflow of newly competitive
imports. In those sectors one would expect a contraction of that sector,
layoffs, and wages decreases. If the gains to the export sector outweigh the
losses to the import sector the net gains are positive. This leaves the ‘possi-
bility’ that the winners can compensate the losers or that the gains from
trade may be used to stimulate pro-poor growth.
Drawing on the framework on trade and environment outlined above,
the third column in Table 25.1 outlines potential environmental winners
and losers. There can possibly be environmental benefits from being an eco-
nomic winner as well. First, this can occur if trade liberalization causes a
compositional shift toward less environmentally degrading forms of eco-
nomic activity. Second, there is also the possibility of environmental
improvements in relatively environmentally destructive sectors if those
sectors attract large amounts of investment from firms that transfer state-
of-the-art environmental technologies to the exporting sector.
Trade liberalization can also have negative effects. Of course, trade lib-
eralization can cause a composition effect where the economy moves
toward more pollution-intensive industry. One example of this is Brazil,
which liberalized trade in the 1990s and subsequently its exports became
more pollution-intensive (Young, 2004). Scale effects can also adversely
impact the environment, and the health and safety of the workers in eco-
nomically expanding plants that may have to handle increasing amounts of
pollution-intensive inputs.
It is often overlooked that there can also be adverse environmental
effects of being a trade policy ‘loser’. Some analysts argue that the shrink-
ing of a sector that is environmentally degrading is beneficial for an
economy because by definition less economic activity will equal less pol-
lution. On the other hand, a shrinking sector can bring with it environ-
mental liabilities that may cost taxpayers increased funds. Moreover, from
a political economy perspective, shrinking sectors may put pressure on
governments to turn a blind eye to environmental performance in order to
maintain an economic presence (in other words causing a worsening tech-
nique effect).
Losing economic comparative advantages can also hurt the environment
when losing sectors are those related to positive externalities. In Mexico,
small holder maize growers are finding it hard to compete with a flood of
US corn imports after the North American Free Trade Agreement
(NAFTA) was signed. Mexico is the center of origin for maize and the
cradle of maize crop genetic diversity. Thus, pressure to leave the land or
convert it to other crops is threatening such diversity and global food secu-
rity (Nadal and Wise, 2004). Smallholders cultivating maize are generating
positive externalities of protecting a global public good and maintaining
diversity. Yet, such prices are not reflected in their goods. Similar examples
are with jute production in Bangladesh (Boyce, 2002).
In theory then, trade liberalization can benefit the environment but only if
winners compensate the social and environmental losers with the gains from
trade in the form of institution building for sustainable development. This is
very difficult in developing countries for political, cultural and economic
reasons. On the political level, trade liberalization costs a great deal of polit-
ical capital to begin with. It is then very difficult to get the winners of a trade
policy to agree to give away a portion of their gains. What’s more, many in
developing countries may not accept compensation for losing. Indigenous
groups see themselves as having ancient rights to land and resources and may
not be willing to be ‘bought off’ (Kanbur, 2001). Even if they could be bought
off, at what price? The fields of ecological and environmental economics have
made great strides in recognizing that there are values for the environment
that need to be incorporated into the price scheme to allocate resources in a
more socially optimal manner. However, the methodologies for identifying
the exact prices for those values are very much in their infancy, controversial,
and many times inappropriate – especially in developing country contexts
(Ackerman and Heinzerling, 2004).
3. Trade and sustainable development: evidence
The evidence on the effects of the recent wave of trade liberalization on
sustainable development is mixed. Trade liberalization has not been linked to economic growth and therefore has not brought many opportunities for
developing the necessary institutions to make trade work for development.
It is estimated that the annual gains from the Uruguay Round were
approximately $200 billion annually. However, it has also been shown that
70 per cent of those gains have gone to the developed countries and most
of the rest has gone to a small handful of developing countries. Indeed, in
the first six years following the Uruguay Round, it is estimated that the 48
LDCs were worse off by $600 million per year (Stiglitz and Clayton, 2004).
Thus, when the developed world proposed another round of global trade
talks in 2001 in Doha, Qatar, the developing countries accepted on condi-
tion that development form a core part of the negotiations.
In a comprehensive review of the literature, Rodriquez and Rodrik
(2001) have shown that there is no systematic relationship between a
nation’s average level of tariff and non-tariff barriers and its economic
growth rate. An assessment of the literature on FDI and development came
to similar conclusions; FDI alone was not correlated with local spillovers
in developing countries (Gallagher and Zarsky, 2005). Whereas developing
country per capita income growth was 3 per cent on an annual basis
between 1960 to 1980 – a period of considerable levels of state management
of developing economies – the more integrated period from 1980 to 2000
yielded average annual growth rates of 1.5 per cent in the developing world.
The latter rate is less than 1 per cent per annum if India and China (two
interventionist countries) are taken out (Chang, 2003).
More recent work has shown that trade liberalization alone is not a
sufficient condition for economic growth. Institutional innovation coupled
with macroeconomic and political stability are key to the growth process
(Wacziarg and Welch, 2003). Indeed, there is now fairly widespread agree-
ment among growth economists that institutional quality is the strongest
driver of economic growth, more so than trade or geographical contexts
(Rodrik, 2004). Whereas traditional trade theory emphasizes obtaining
welfare gains through specialization, institutional approaches emphasize
obtaining welfare gains from increasing productivity by means not neces-
sarily based on specialization.
The evidence on the environmental effects of trade is mixed as well.
Economic integration is contributing to worldwide environmental degra-
dation, but not so much because the developing world is serving as a ‘pol-
lution haven’ for developed world pollution. In 1992, the World Bank’s
World Development Report made the case that while trade-led growth may
cause sharp increases in environmental degradation during the early stages
of economic development, such degradation would begin to taper off as
nations reached ‘turning points’ ranging between $3000 to $5000 GDP per
capita (World Bank, 1992). The Bank was generalizing from a landmark 1991 paper by economists Gene Grossman and Alan Krueger. Working
with a cross-sectional database of largely developed and some developing
countries, this article examined the relationship between ambient concen-
trations of criteria air pollutants and GDP per capita. When they plotted
their regression results they found that lower income nations had higher
rates of pollution per capita where the reverse occurred for higher income
nations (Grossman and Krueger, 1993).
This relationship became known as the environmental Kuznets curve
(EKC: see Chapter 15), borrowing its name from the landmark article by
Simon Kuznets that found a similar relationship between income inequality
and GDP per capita in a cross-section of countries in the 1950s (Kuznets,
1955). For the developed countries, the three factors described earlier (scale,
composition and technique effects) are seen to be interacting – as income
has grown the composition of industry has shifted toward relatively less
pollution-intensive economic activity while at the same time improvements
in technology and environmental regulation have occurred. Although
overall levels of growth (scale) have vastly increased, they have been offset
by composition and technique effects.
To this day, generalizations of these findings have been used to make the
claim that nations should grow now through trade liberalization and worry about the environment later (Bhagwhati, 1993). EKC studies have become
a cottage industry, with close to a hundred articles published since the orig-
inal 1991 piece (see Panayatou, 2000; Stern, 1998). What is ironic is the fact
that, as the policy community has rushed to generalize the EKC in the polit-
ical realm, the consensus in the peer-reviewed academic literature on the
EKC has become much more cautious. Most importantly, the literature
shows that the empirical evidence for the EKC is relatively weak and
limited. While a thorough review of that literature is beyond the scope of
this chapter, the following limits can be outlined (for a good review see
Stern, 1998, and Chapter 15 of this volume):
EKCs are limited to a small number of pollutants.
EKC studies have relatively small representation from developing
EKC turning points are much higher than original estimates.1
Income isn’t the only factor contributing to an EKC. Later studies
have shown that factors such as the degree of political freedom and
democracy in a nation, population density, economic structure, and
historical events (such as the oil price shocks of the 1970s) correlate
with reductions in pollution.
Limited evidence for the EKC in single-country trajectories. The
majority of early EKC studies utilize cross-sectional or panel data of
largely developed countries to estimate the relationship between
income and pollution.
Yet, opponents of free trade often claim that trade liberalization will result
in a mass migration of pollution-intensive industry from developed coun-
tries with stringent environmental regulations to developing countries with
lax environmental standards. Not only will such migration cause increases
in pollution in developing countries, they argue that pressure will then be
exerted on developed country standards in the name of competition –
effectively creating a ‘race-to-the-bottom’ in standards.
Like the EKC literature, it is also ironic that the majority of the peer-
reviewed literature has found very limited evidence for pollution havens but
that the policy community continues to cite it as a dire consequence of
trade liberalization. Very recently however, a small handful of papers have
found evidence for pollution havens. Again, a full review of the literature is
beyond the scope of this chapter. However, extensive studies have been con-
ducted at the global and regional level. There have been a number of widely
cited studies on international trade flows and environmental regulations.
Many have identified and studied a set of ‘dirty’ industries, where regula-
tions might be expected to have the greatest effect. Although the definitions of dirty industries vary, many of the same industries tend to show up on
everyone’s lists.
James Tobey looked at the behavior of 23 nations in 1977, testing
whether environmental policy affected the patterns of trade in commodi-
ties produced by dirty industries (Tobey, 1990). He defined a dirty, or
pollution-intensive, industry as one where pollution abatement costs in the
United States were 1.85 per cent or more of total costs. Industries meeting
this standard were pulp and paper, mining, iron and steel, primary non-
ferrous metals, and chemicals. For international comparisons Tobey
created an ordinal variable ranging from 1 to 7 to measure the level of strin-
gency of a country’s environmental policies. He then regressed net exports
of each country’s dirty industries on their factor inputs (land, labor, capital
and natural resources) and on environmental stringency. In no case did he
find that environmental stringency was a statistically significant determin-
ant of net exports.
World Bank researchers Patrick Low and Alexander Yeats tested whether
developing countries gained a comparative advantage in pollution-intensive
products during the period 1965–88 (Low and Yeats, 1992). Their model
relies on calculation of revealed comparative advantage (RCA), defined as
the share of an industry in a country’s total exports, relative to the indus-
try’s share of total world exports of manufactures. Low and Yeats looked at
RCAs of 109 countries for pollution-intensive industries. Their list of pol-
lution-intensive industries, selected on the basis of pollution abatement
costs in the US, consists of iron and steel, non-ferrous metals, petroleum
refining, metal manufacturing, and pulp and paper. Low and Yeats found
that for these industries the RCAs of developing countries were growing rel-
ative to those of industrial countries. They observed decreases in dirty
industry RCAs in the developed world and increases in Eastern Europe,
Latin America and West Asia.
Results along the same lines were found in a study by Mani and Wheeler
(1998). They found that from 1960 to 1995, pollution-intensive output as a
percentage of total manufacturing fell in the OECD and rose steadily in the
developing world as a whole. However, the location of pollution havens has
changed over time because economic growth in any one country brings
‘countervailing pressure to bear on polluters through increased regulation,
technical expertise, and clean sector production’ (Mani and Wheeler,
1998, p. 244).
Using a different methodology, another World Bank team looked at
trade liberalization and the toxic intensity of manufacturing in 80 countries
between 1960 and 1988 (Lucas et al. 1992). Analyzing aggregate toxic
releases per unit of output, they identified metals, cement, pulp and paper,
and chemicals as the dirtiest industries. Lucas et al. found that the dirty(toxic-intensive) industries grew faster in the developing countries as a
whole, but this growth was concentrated in relatively closed, fast growing
economies, rather than in the countries that were most open to trade.
Regional work on Latin America has generated similar results (Birdsall and
Wheeler, 1993).
Very recently however, a handful of studies have indeed found evidence
of pollution havens in the world economy. A study by Cole (2004) exam-
ines North–South trade flows for ten air and water pollutants. Cole finds
evidence of pollution haven effects, but finds that such effects are quite
small relative to other explanatory variables. Another study, by Kahn and
Yoshino (2004) looks at bilateral trade data over the years 1980 to 1997 for
128 nations for 34 manufacturing industries, and examines how low-,
middle-, and high-income nations differ regarding their income elasticity in
exporting pollution-intensive products. They find that among nations
outside of regional trade blocs there is general support for the pollution
haven hypothesis. As national incomes rise, exports of pollution-intensive
products decrease relative to exports of ‘cleaner’ goods. Nations partici-
pating in regional trading arrangements have slightly weaker pollution
haven effects than those observed outside of regional trading blocs.
The reason why so many of these studies fail to find evidence for pollu-
tion havens (or find small effects) in developing countries is that the eco-
nomic costs of environmental degradation are relatively much smaller than
many other factors of production – especially those that determine com-
parative advantage. In general, the developing world is factor abundant in
unskilled labor that takes the form of manufacturing assembly plants. On
average, such manufacturing activity is relatively less pollution-intensive
than more capital laden manufacturing activities such as cement, pulp and
paper, and base metals production. A full review of this literature is beyond
the scope of this chapter (see Jaffe, 1995 and Neumayer, 2001, for compre-
hensive reviews of this literature).
A snapshot of the record on trade and sustainable development in Latin
America is useful. Perhaps no region of the world has experimented with
economic integration more that Latin America. Since the late 1980s, many
Latin American nations have introduced a deep package of reforms includ-
ing: reducing tariffs and other protectionist measures; reducing barriers to
foreign investment; restoring ‘fiscal discipline’ by reducing government
spending; and promoting the export sector of the economy. According to
a sweeping assessment of the impacts of the reforms conducted by the
Economic Commission for Latin America and the Caribbean (ECLAC),
the region’s economies grew at an annual rate of less than 2 per cent
between 1980 and 2000, compared to a rate of 5.5 per cent between 1960
and 1980. Growth was faster during the 1990s than in the 1980s, but it still did not compare to the period previous to the reforms. Chile is an excep-
tion where growth rates almost doubled over the past 20 years compared to
the 1960 to 1980 period (Stallings and Peres, 2000). The ECLAC report
concludes that the reforms contributed to an increase in poverty and
inequality in the region.2 As a result, there has been widespread popular
resistance, which is putting added pressure on governments to question
both the Washington Consensus and free-trade agreements.
The United Nations Environment Program (UNEP) and ECLAC report
that environmental trends in the region continue to worsen (ECLAC/UNEP,
2003). Increasing urbanization and the modernization of agriculture are
leading to increases in air, soil and water pollution and subsequent adverse
human health effects. The report notes that the health problems associated
with deteriorating air quality and toxic substances are as serious as the health
problems previously caused by underdevelopment. Finally, although on
average industrial manufacturing has shifted toward relatively ‘cleaner’
sectors, increasing rates of pollution are occurring because of ‘serious short-
comings’ in environmental management.
Specific to the EKC and pollution haven theories, on average, countries in
Latin America and the Caribbean experienced positive composition effects,
meaning that the composition of industry shifted toward ‘cleaner’ produc-
tion. However, pollution in Latin American industry is increasing because
nations in the hemisphere lack the proper policies to stem the environmen-
tal consequences of trade-led growth in those sectors. In addition, many
firms lack the will or ability to adhere to the environmental ramifications of
their operations, and non-governmental organizations have not always been
there to apply appropriate pressure. Of the case studies conducted here,
Brazil has actually experienced a general increase in pollution-intensive
activity, whereas Mexico follows the general trend (WGDEA, 2004).
4. Trade and sustainable development: policy and institutions
The evidence just summarized underscores the need to couple any eco-
nomic integration with social and environmental policy at the local,
national and international level. The fact that there is only mixed evidence
that trade liberalization is associated with growth shows that trade must be
coupled with institution building. The fact that there is limited evidence for
the EKC shows that economic integration cannot be relied on for auto-
matic environmental improvements. Indeed, the evidence shows that the
lack of effective institutions in the presence of economic integration has
exacerbated longstanding problems in the developing world.
However, a silver lining lies in the fact that there is little evidence of pol-
lution havens. Such evidence suggests that strengthening environmental
institutions and standards in developing and developed countries alike will not deter foreign and domestic investments. Because the abatement costs of
pollution are so small relative to other key costs, firms will not move to or
from developing countries as regulations rise (at least to US levels).
Michael Porter’s hypothesis (Porter and van der Linde, 2002), that regula-
tion-inspired innovation to decrease environmental degradation can lead to
reduced costs and therefore increased competitiveness, also deserves to be
spelled out. Environmental regulation can lure firms to seek ways of
increasing resource productivity and therefore reduce the costs of inputs.
Such ‘innovation offsets’ can exceed the costs of environmental compli-
ance. Therefore, the firm that leads in introducing cleaner technologies into
the production process may enjoy a ‘first-mover advantage’ over those
industries in the world economy that continue to use more traditional,
dirtier production methods. (For a critical rebuttal see Palmer et al., 1995.)
Rhys Jenkins (1998) has offered a synthesis of the Porter hypothesis,
arguing that regulation is more likely to lead to ‘innovation offsets’ under
three conditions. Note that each condition requires that a firm has sub-
stantial market power in an industry in which there is substantial innova-
tive activity. First, because cost reductions are more likely to occur where
new clean technologies are developed rather than in industries that adopt
end-of-pipe solutions, the level of R&D is likely to be a factor in deter-
mining the impact on competitiveness. Second, innovation offsets are more
likely in industries or firms that have the ability to absorb environmental
costs, which is most often determined by profit margins and firm size.
Finally, they are more likely in firms that have the ability to pass increased
costs on to consumers in the form of higher prices.
Creative policy does not have to be designed by government. Conroy
(2002) analyzes how advocacy organizations have used certification pro-
cesses to reward firms that produce and trade goods that use high social and
environmental standards in their production processes. Through such
efforts, the Forest Stewardship Council has certified 60 million acres of
forest between 1995 and 2001, accounting for more than 5 per cent of the
world’s working forests. Working on the demand side of the equation,
advocacy groups set up market campaigns to pressure firms to buy these
products. Indeed, some retail giants are now actually seeking to participate
in these processes. When governments or citizens’ groups recognize more
sustainable practices in the developing world, there are avenues to gain
market access for production processes that would be deemed inefficient by
an unfettered marketplace.
Although developing countries agreed to enter a new round of trade
negotiations only on the condition that development would be the center-
piece, there are growing concerns that this promise will go unfulfilled. Key
among those concerns is the notion that a new trade agreement will not give the developing world the ‘policy space’ to use the very instruments and tools
that many industrialized nations took advantage of to reach their current
levels of environmental protection and development. The verdict is still out
on this, but new agreements must give countries the space to establish the
necessary institutions to steer growth toward development. If that doesn’t
occur, the world trading system will continue to confuse the means of
increasing trade and investment with their ends of sustainable development.
Besides preserving the space for national efforts, three models of institu-
tions have emerged that deal with trade and sustainable development link-
ages at the regional and global levels. On the one hand the European Union
(EU) has a very deep set of linkages between integration and sustainable
development, whereas the WTO has quite limited linkages. Trade arrange-
ments negotiated by the United States are somewhere in the middle.
The EU has made decreasing economic, social and environmental dis-
parities a cornerstone of its regional integration strategies. According to
Anderson and Cavanagh (2004) the EU made $324 billion in development
grants to this end between 1961 and 2001. Annual aid for a new member of
the EU can be as high as 4 per cent of GDP. As a result, the relatively less
well-off European countries have improved their social and environmental
situations as well as having benefited economically from integration.
Coupled with development funds the EU has established regional social
and environmental ministries that establish independent standards and
allow for civil society participation and monitoring as well.
In its regional arrangements, the US allows for a much more limited
level of linkages between trade and sustainable development. The major-
ity of regional trade arrangements (such as the US agreements with Chile,
Jordan, Morocco, Singapore, Central America and others) have text
concerning environmental matters but leave out social concerns com-
pletely, set up no institutions, and have very limited avenues for civil society
participation. Indeed, according to Anderson and Cavanagh (2004) EU
development funds are approximately ten times the amount of US
economic assistance grants to all of Latin America. In the largest US
regional arrangement, the North American Free Trade Agreement
(NAFTA), a parallel agreement set up an environmental institution called
the Commission for Environmental Cooperation. With an annual budget
of $9 million the institution can do little more than provide technical assis-
tance to the parties involved, but it does allow interesting levels of civil
society participation. NAFTA does not include any mechanism to address
regional inequality. Thus, the experience of Ireland, Spain and Greece
with EU development funds has resulted in increasing standards of living
as well as social and environmental improvements, Mexico has become
worse off since NAFTA – incomes have grown a mere 1 per cent annually and poverty and inequality have worsened. What’s more, the economic
costs of environmental degradation have reached 10 per cent of GDP
annually (Gallagher, 2004; Gallagher and Zarsky, 2005).
On the world stage, the WTO has limited formal linkage between sus-
tainable development and trade, though that may be changing. On the
social end, the WTO (and the GATT before it) have allowed for ‘special and
differentiated treatment’ for developing countries – allowing them to
deploy many of the development policies that were used in the developed
world in the past but are now not allowed. However, successive rounds of
WTO negotiations are shrinking the policy space for such policies.
Agreements on intellectual property rights, investment rules, and services
have all made it much more difficult for developing nations to deploy
the development policies used by middle and high income nations in the
twentieth century (Gallagher, 2005).
On the environmental front, there has been a longstanding controversy
regarding the extent to which WTO laws restrict the ability of nations and
the world community to establish effective environmental policy. At the
national level, numerous cases have gone before the WTO claiming
that national environmental policies have served as unfair trade barri-
ers to member nations. Two famous cases involving tuna and shrimp
respectively occurred when developing country governments challenged
US laws that restricted imports of these fish when they were caught by
using techniques that also killed dolphins or sea turtles. Developing coun-
tries saw such laws as unfair trade barriers. The WTO has ruled that it
does not object to environmental policy per se, but to environmental poli-
cies that are trade restrictive. The US has since amended these laws
(Neumayer, 2001).
Although there has never been a WTO case to this effect, at the multi-
lateral level there is growing concern that Multilateral Environmental
Agreements (MEAs) will be overridden by WTO laws. Many MEAs use
trade restrictions as an enforcement mechanism and the fear is that such
mechanisms would be deemed WTO illegal and thus reduce the effective-
ness of MEAs and ‘chill’ the negotiations of future MEAs (Neumayer,
2001). In response to this the Doha Round of WTO negotiations (2001 –
present) is charged with examining the relationship between MEAs and the
Some scholars and policy makers argue that more needs to be done, that
indeed a ‘World Environmental Organization’ should be established in
order to serve as a counterweight to the WTO (Esty, 1997; Speth, 2004).
Indeed, such an institution has also been proposed by none other than
former WTO head Renalto Ruggerio: ‘I would suggest that we need a
similar multi-lateral rules-based system for the environment – a World Environment Organization to also be the institutional or legal counterpart
to the WTO’ (Ruggiero, 1999).
Discussion of a World Environmental Organization has become quite
controversial, with many in the environmental community arguing against
it on numerous grounds. Some say that the existing global environmental
regime (surrounding such bodies as the United Nations Environment
Program) has not been able to fulfil its mandate and the focus should be
reforming the existing architecture, not creating new institutions that could
become plagued with the same problems (Najam, 2003).

26 The international politics of sustainable development John Vogler :

1. Introduction
There are many definitions of sustainable development, but few betray its
political nature. One exception is to be found in a 1992 statement by
Maurice Strong, the moving force behind the United Nations Conference
on Environment and Development (UNCED) held in that year.
Sustainable development involves a process of deep and profound change in the
political, social, economic, institutional and technological order, including rede-
finition of relations between developing and more developed countries.1
From the perspective of international politics, the critical part is the ‘rede-
finition of relations between developing and more developed countries’.
Sustainable development represented a political construct designed to facil-
itate a bargain across the deep structural divide between North and South.
This would allow global negotiation on the environmental concerns voiced
by developed states through the necessary accommodation of the economic
and political demands of the developing countries. In the much changed
and highly differentiated circumstances of the early twenty-first century
international system, it continues to serve this function. This article seeks to
outline the way in which the concept has been moulded by international pol-
itics, how it reflects not only the balance between the G77/China and the
OECD countries but other significant changes in the world system as well.
The concept has always been associated with the United Nations organ-
ization and landmarks in its evolution are provided by three great UN con-
ferences held over the 30 years from 1972 to 2002; at Stockholm, Rio and
Johannesburg. In this period there has been a discernible shift from a near
exclusive concern with the environmental predicament, to an integrated
conception of environmental, economic and social determinants of the
human future, in which the former is by no means dominant.
A conventional survey of these developments might regard sustainable
development as a new arena for the expression of the national interests of
a widening range of states, at various levels of economic development, with
their own political and commercial agendas to pursue. However, the
concept was not just the rhetorical plaything of self-interested states. As it became institutionalized within the UN system, it began to take on a life of
its own, to spawn new commissions and meetings and to re-shape the way
in which other organizations defined their missions. It came to be closely
associated with the growing significance of non-state actors and particu-
larly the NGOs that populate what has come to be termed ‘global civil
society’. It may also be argued that, as well as reflecting the prevailing polit-
ical and economic order, sustainable development, or more accurately the
forces that it represents, is inherently subversive of that order.
2. Stockholm and the origins of sustainable development
The emergence of the sustainable development concept can be understood
in terms of the changing structure of the international political system after
1945 and more specifically, the evolution of the United Nations organiza-
tion. In 1945, at its foundation, the UN comprised 51 members – the over-
whelming majority being developed states. European colonial empires
survived, although mortally damaged by the events of the Second World
War. In 1947 India and Pakistan were granted their independence and in
the ensuing 20 years the old colonial empires in Africa and South and
South-East Asia were almost entirely liquidated. This surge of new inde-
pendent states transformed the membership of the United Nations. By
1965 total membership was 114, of which more than 80 were newly inde-
pendent developing states. Developing countries, courted by both camps in
the Cold War, had since the Bandung meeting in 1955 attempted to pro-
claim their ‘non-alignment’.
Although sometimes divided by their allegiances and indeed lack of alle-
giance in the Cold War, the newly independent states were able to unite
around a number of other issues such as opposition to continued colonial-
ism and to the Apartheid regime in South Africa. Above all, they shared a
consciousness of their relative weakness in the international economy, of
their dependence on their former colonial masters and of the need to
promote development. By the early 1960s demands for action on the
inequities on trade and development and for increased aid funding had
become insistent in the UN General Assembly leading to the formation in
1964 of UNCTAD (The United Nations Conference on Trade and
Development). It was in this context, on 15 June 1964, that the caucus of
developing world states, the G77 (Group of 77) was founded. It now has
some 132 member states including China (it is quite usual to refer to the
G77/China). G77 Chapters will now be found at all major multilateral
organizations and conferences but the heart of its activity remains the
United Nations General Assembly, and the G77’s primary decision-making
body is its Ministerial Meeting, held annually at the beginning of the
regular session of the UN General Assembly in New York.
The G77 caucus was able to command a significant majority in the
General Assembly and although its resolutions do not have the binding
character of those of the Security Council, they can and do serve to set
the international agenda and to direct the work of the organization.
Thus, although militarily and economically weak, in relation to the devel-
oped countries, the G77 could deploy an organizational weapon. This
they proceeded to do in a number of contexts with the general aim of
advancing their own economic development and addressing the struc-
tural inequities of the existing international system. In 1967, the General
Assembly held a Special Session on development followed by its adop-
tion, in October 1970, of the 0.7 per cent of GNI aid target for the
developed countries.2
Thus, by the early 1970s, the development agenda was well established
within the UN General Assembly. By contrast, environmental concerns
had achieved very little international profile and were only just beginning,
during the 1960s, to enter the politics of developed states, as issues such as
nuclear contamination and transboundary sulphur deposition (acid rain)
began to register. There was sufficient interest, however, to stimulate calls
for UN action on international environmental issues and a conference was
proposed by the Swedish government in early 1968. By December of that
year the UN General Assembly had agreed to convene the United Nations
Conference on the Human Environment (UNCHE) at Stockholm in 1972.
The vote was unanimous even though there were misgivings amongst the
G77 that international discussions of the environment might be used as an
excuse to restrict development and curtail flows of aid (Engfeldt, 1973). It
was important to enlist the continuing support of a General Assembly
majority by establishing connections with the development agenda. This
landmark meeting, sponsored by the UNCHE Preparatory Committee
(Prep Com) and held in a motel in the Swiss village of Founex in June 1971,
first gave political definition to what later became sustainable development
(Caldwell, 1990, p. 52). There, a group of 27 experts articulated the links
between environment and development stating that: ‘although in individ-
ual instances there were conflicts between environmental and economic pri-
orities, they were intrinsically two sides of the same coin’ (Founex Report,
1971: 1.5, 2). While in advanced countries economic development might be
identified as the cause of environmental degradation, for the developing
countries development was the only solution to the linked problems of
poverty and degradation. Many of what were to become the perennial
themes of UN debates about sustainability were clearly foreseen at Founex.
The Report stressed that the ‘extent to which developing countries pursue
a style of development that is responsive to social and environmental goals
must be determined by the resources available to them’ and that this must reinforce the advanced countries’ commitment to providing development
aid (ibid., 1.15: 6). This aid should be additional to that already provided
(ibid., 4.17: 29). Environmental issues were recognized as being ‘relatively
marginal’ to countries with pressing development concerns (ibid., 3.12: 21)
and their social and economic policy fell ‘entirely and exclusively within the
sovereign competence of developing countries’ (ibid., 3.1: 15). Finally, the
Report sees, albeit ‘dimly’, some of the trade consequences of the environ-
mental agenda in the developing world: concern that raised standards of
environmental protection would become a form of disguised protectionism
to lock them out of developed world markets and that ecological dumping
might occur (ibid., 4.5: 22–3).
There were many important outcomes of the 1972 Stockholm UNCHE.
They included the creation of the UN Environment Programme (UNEP)
and the setting up of government departments of the environment across
the world.3 At the conference itself the Prime Minister of India, Indira
Gandhi, who was the only other head of government to attend alongside
the sponsor Olaf Palme, attracted much attention with her statement that
‘poverty is the greatest polluter’.4 The conference proceedings were also free
of the Cold War confrontation that tended to impair other international
gatherings at the time because the Soviet Union and its allies operated a
boycott to protest at the non-admission of East Germany. The Stockholm
Declaration, with its 26 Principles, became a significant source for the
development of ‘soft’ environmental law, some of which reflected the
Founex discussions by laying down some essential connections between
environment and development, although the term ‘sustainable develop-
ment’ does not appear in the conference records.5
3. Rio and the sustainable development bargain
While Stockholm provided the bases, in all but name, for international dis-
cussions of sustainable development it was almost immediately eclipsed by
the gathering crisis in the world economy, the 1973 war in the Middle East
and by a new G77 strategy. Dramatic rises in the price of oil in the early
1970s and the willingness of the oil-producing states, gathered in OPEC, to
exert pressure upon the West over the plight of the Palestinian people, pro-
vided the context for a sustained G77 campaign for economic justice and
the structural reform of the international economic system. What became
known as the New International Economic Order (NIEO) was launched by
a 1974 General Assembly Resolution on the Economic Rights and Duties
of states, which called for a major increase in aid transfers and the restruc-
turing of the international commodities system. The demands for NIEO
spread well beyond this and can be traced in G77 positions at a range of
other negotiations. The important third Law of the Sea Conference, which went on throughout the 1970s, included a central Southern demand for
equitable sharing of the supposed mineral riches of the deep seabed and its
declaration as the ‘Common Heritage of Mankind’. Similar ideas appeared
in discussions within that previously apolitical and technical body, the
International Telecommunication Union. Here the demand from the G77
was for ‘equity in orbit’; to change the rules for the allocation of the right
to use the geostationary orbit (GSO) such that developing countries such
as India could benefit from the new satellite technology. In the struggle at
the UN over the NIEO, and over the creation of a Common Fund for
Commodities in particular, the link between underdevelopment and envir-
onmental conservation was relegated to the sidelines. The Coyococ meeting
organized by UNCTAD and UNEP in 1974 is reflective of the times:
The quadrupling of oil prices through the combined action of the oil producers
sharply alters the balance of power in world markets and redistributes resources
massively to some third world countries. Its effect has been to reverse decisively
the balance of advantage in the oil trade and to place close to $100 billions a
year at the disposal of some third world nations. Moreover, in an area critical to
the economies of industrialized states, a profound reversal of power exposes
them to a condition long familiar in the third world – a lack of control over vital
economic decisions. (Coyococ Declaration, 1974: 3)
There is very little in the Declaration on environmental interdependence
but a great deal about resource-based power, the need for third world self
reliance and the failure of market mechanisms. What was proposed (in line
with what was being negotiated for the deep seabed in the Law of the Sea
Convention) were ‘strong international regimes for the exploitation of
common resources’ and the ‘management of resources and environment on
a global scale’ (ibid., p. 8). North–South negotiations proceeded within the
UN context and responses from the developed world, notably the Brandt
Report (Independent Commission on Development Issues, 1980) tended to
focus upon the economic interdependence between the developing coun-
tries of the South and inflation and recession afflicted economies of
Western Europe and the United States.6
The campaign for a NIEO exploited a period of economic turmoil and
political and military retreat by the United States and its allies – the debacle
in Saigon and the rest of Indochina in 1975 followed by the humiliation of
the seizure of its Teheran embassy in 1979. It was soon to be replaced by a
much more strident approach in the West involving an active pursuit of the
Second Cold War against the Soviet Union and a rejection of the politics of
interdependence, replaced by a vigorous pursuit of free market solutions.
Amongst the first casualties were the North–South dialogue which essen-
tially collapsed at the Cancun Conference of 1981 and the Law of the Sea Convention (signed but not ratified by the US and her allies in 1982). The
interesting question is how and why the seeds of the Brundtland Report
(WCED, 1987) came to be sown and nurtured in these rather unpromising
circumstances. The Commission itself was set up by the General Assembly
in 1983 and reported in 1987. Its analysis is well known, it built upon what
had been achieved at Stockholm and provided the most politically signifi-
cant of all definitions of ‘sustainable development’. By 1987 political con-
ditions were much more receptive. The Second Cold War was drawing to a
close with the Intermediate Nuclear Forces (INF) agreement of that year.
In December 1989 Resolution 44/228 of the General Assembly agreed to
convene a second great conference – UNCED – in 1992.
The concept of sustainable development acquired political impetus
through rising public concern in the developed countries over the new and
alarming phenomenon of global environmental change. In some ways it
replaced fears of nuclear Armageddon that had prevailed in the early 1980s.
Preparations for the conference ran alongside the intergovernmental nego-
tiations for Climate and Biodiversity Conventions. For the G77 it provided
a new opportunity to restore some of the negotiating credibility that had
been lost with the collapse of the NIEO. According to one British diplo-
matic participant:
The Brundtland Report shows a hard headedness uncharacteristic of such exer-
cises in the emphasis it gives institutional factors. But the genius of the piece lies
in its adoption and promulgation of the concept of ‘sustainable development’.
In one neat formula, Mrs Brundtland provided a slogan behind which first world
politicians with green electorates to appease, and third world politicians with
economic deprivation to tackle, could unite. The formula was of course vague,
but the details could be left for later. (Benton, 1994: p. 129)
Rio was preceded by a series of Prep Coms which developed key confer-
ence texts, Agenda 21 and the Rio Declaration, along with the separate
intense negotiations for Climate and Biodiversity which were scheduled to
provide completed texts for formal signature at Rio. The UN Framework
Convention on Climate Change (UNFCCC), like the other Conventions,
had to grapple with North–South issues and questions of responsibility. To
do so the Convention includes the important principle of ‘common but
differentiated responsibilities’ under which only the developed Annex I
countries are obligated to make emissions reductions commitments in the
first instance.7 Financial assistance in terms of ‘capability building’ is pro-
vided for the developing countries to fulfil their responsibilities in terms of
providing national reports. North–South difficulties were more evident in
the bad-tempered negotiations for the Convention on Biodiversity (CBD),
involving arguments about the extent of developed world finance that would support the preservation of biodiversity resources mainly located in
the South and the sharing of economic benefits from the utilization of ‘sov-
ereign’ biodiverse resources by developed world biotechnology firms.8
There was also an attempt to follow up Western public and NGO concerns
over the fate of tropical forests with a convention to conserve them, but this
foundered on developing country suspicions of violation of economic
sovereignty. It was replaced at Rio with a non-binding statement of forest
The conference itself proved to be an international event on an unpre-
cedented scale as heads of government vied to make their mark on what
was dubbed the Rio ‘Earth Summit’. Its very title, connecting Environ-
ment and Development, was indicative of North–South bargaining at the
UN, in which demands for international action on the environment were
set against claims for additional development aid and technology trans-
fer.9 At the Conference itself the most serious argument concerned the
extent to which developed nations would ‘pay’ for the implementation of
UNCED decisions on sustainable development with additional aid con-
tributions. Major aid donors re-packaged their existing programmes and
promised new funds, but the net results appear to have been minimal and
the oft-repeated UN target of 0.7 per cent of GNI is still far short of ful-
filment.10 The key outputs of the Conference (as opposed to the FCCC
and the CBD) are to be found in the Rio Declaration, Agenda 21 and the
Commission on Sustainable Development (CSD). All are quite explicitly
concerned with sustainable development and it is thus, at the conclusion
of the Earth Summit, that the concept truly arrives on the international
Agenda 21, doubtless the most enduring product of the Prep Coms and
the conference, is a vast (over 500 pages) compendium of agreed good prac-
tice and advice for achieving sustainable development in almost every con-
ceivable area, except the Antarctic. It has no legal authority but has proved
to be widely influential even down to the level of the many local Agenda 21s
that were created in the aftermath of Rio. Ten years later the next great UN
conference at Johannesburg pledged itself to discuss how the contents of
Agenda 21 might be better implemented. The Rio Declaration on Environ-
ment and Development also mentions the achievement of sustainable devel-
opment in ten of its 27 clauses. What had been intended as a visionary, brief
and inspiring Earth Charter was, when put into the hands of the Prep Com,
turned into an example of how the sustainability concept can be trans-
formed by international politics into a portmanteau of special interests,
contradictory approaches and inoffensive platitudes. Thus a right to devel-
opment, national resource sovereignty, free market economic systems, the
precautionary approach and common but differentiated responsibilities are all present alongside clauses such as Principle 25: ‘Peace, development and
environmental protection are interdependent and indivisible’. As one com-
mentary describes it: ‘Far from a timeless ethic, it was now a snapshot of
history’ (Grubb et al., 1993, p. 85).11 As such, the Declaration provides a
useful indicator of how far the new concept of sustainable development
had moved on from the discussions of environment and development 20
years previously (it itself consciously sought to build upon the Stockholm
Principles). A comparison of the two reveals some enduring themes. The
famous Stockholm Principle 21 is repeated verbatim as Rio Principle 2 and
there are many new concerns, legal innovations and the rights of women
and indigenous people that figure in the later document. However, the bulk
of the Stockholm conclusions were concerned with strictly environmental
matters while acknowledging development issues, whereas at Rio the
balance is noticeably shifted towards a range of socio-economic concerns.
This change is certainly reflected in subsequent, generally accepted, UN
conceptualizations in terms of three ‘pillars’ designed ‘. . . to ensure a
balance between economic development, social development and environ-
mental protection as interdependent and mutually reinforcing components
of sustainable development’ (United Nations General Assembly,
A/57/532/add.1, 12 December 2002).
4. Johannesburg: sustainable development under globalization
Rio institutionalized a process of continuing dialogue on sustainable devel-
opment and spread the concept across the UN system and beyond. An
important consequence was its still incomplete influence on other organ-
izations such as the World Bank, which had been traditionally prone to
funding decisions based upon narrow considerations of economic welfare.
Other bodies, such as the EU where it achieved Treaty status as an objec-
tive of the Union, came to use the concept as a means of attempting to inte-
grate disparate areas of policy and resolve contradictions between them. A
similar move, from environmental policy to the governance of sustainabil-
ity, was observable in the academic literature from Vogler and Jordan
(2003). In terms of the core politics of the UN, the creation of the
Commission on Sustainable Development, set up by the General Assembly
at the instigation of the UNCED, served to keep the Rio agenda alive by
institutionalizing the formal review of the implementation of Agenda 21 by
states and ‘major groups’. The CSD works under the auspices of the
Economic and Social Council which elects its 53 state members on a
regional basis. In 1997 a full-scale consideration of Rio ‘plus 5’ was held by
a General Assembly Special Session to be followed by the convening of a
new summit level UN conference, the 2002 World Summit on Sustainable
Development (WSSD) to be held at Johannesburg.
Rio occurred in the immediate aftermath of the Cold War, the Soviet
Union having finally collapsed in 1991. In the ensuing ten years the United
States occupied a hegemonic position and many of the old boundaries and
economic divisions in the system were obliterated in a process, hardly
noticed at Rio, of globalization. An integral role was played by the creation
of a new trade regime under the World Trade Organization (WTO), set up
in 1995 as a consequence of the previous GATT Uruguay Round.
Although deep and abiding inequalities remained, particularly between
the mass consumption societies of the OECD and parts of Africa, the
landscape of North–South relations was subject to radical alteration.
Membership or impending membership of the WTO and increasingly full
participation in the global economy meant that some key members of the
G77, such as China, India and Brazil, achieved such high rates of growth
that they came to be regarded as future economic superpowers.12 This
inevitably raised the question of the environmental consequences and sus-
tainability of such growth and of the justification for ‘common but
differentiated responsibilities’ in such radically altered circumstances. At
the same time the inclusion of agriculture in trade negotiations and the
increasing presence of powerful Southern economies at the WTO led to a
new site of North–South confrontation in what was optimistically termed
the Doha Development Round.13 One potential casualty was any attempt
to introduce environmental standards into international trade practices,
viewed (as had been predicted at Founex) with immense suspicion by devel-
oping countries as a form of covert protection for developed world markets.
These developments placed further strain on the G77 coalition, opening up
gaps between oil producers, middle income and fast growing economies
and the wretchedly poor Highly Indebted and Poor Countries (HIPC). At
the same time the North was hardly monolithic as significant differences,
traceable across most of the environmental negotiations of the 1990s,
opened up between the United States and the European Union.
Within this political context the Johannesburg Conference confirmed a
trend, evident since Rio, of the increasing importance of the socio-
economic pillars of sustainable development. The environmental agenda at
the two previous UN conferences had been sustained by peaks in the public
‘attention cycle’ of major developed countries. Public concern at environ-
mental degradation had motivated governments in the late 1960s, and the
Rio meeting had been driven on by the ‘discovery’ of stratospheric ozone
depletion and the enhanced greenhouse effect at a time when Cold War
fears had rapidly subsided. Johannesburg occurred amidst mounting devel-
oped world preoccupation with terrorism and stability in Central Asia and
the Middle East. At the same time, the plight of much of the African con-
tinent, ravaged by AIDS, warfare and under-development, was justifiably prominent in the minds of governments and the public. The Rio agenda
reflected the underlying power relations between North and South, with the
South being reduced to obstruction over particular agreements (such as
that proposed for forestry), while attempting, unsuccessfully, to obtain
some compensatory leverage to increase aid flows and technology transfer.
The WSSD occurred under changed circumstances. Held in South Africa,
it highlighted a common international concern with the urgency of poverty
alleviation alongside the increasing strength of some developing world
economies under conditions of rapid globalization.
WSSD incorporated the concept of sustainable development throughout
its deliberations and was initially dubbed ‘the implementation summit’.
Inevitably demands for additional financial resources and technology
transfer continued but much of the debate had already been pre-empted by
the establishment of the Millennium Development Goals in 2000 and by
the March 2002 meeting of finance ministers which set out the ‘Monterrey
Consensus’ on development funding.14 These, as well as the WTO’s Doha
Round, were frequently referred to at the Conference. Pride of place in the
Johannesburg ‘Plan of Implementation’ (UN, 2002), which formed the
principal output of the Conference and the plenary sessions of the WSSD,
was given to poverty eradication. It was described as ‘the greatest global
challenge facing the world today and an indispensable requirement for sus-
tainable development’ (ibid., p. 7), in effect confirming Indira Gandhi’s
statement, 30 years before, that ‘poverty was the greatest polluter’. Closely
associated were a range of so-called ‘WEHAB’ issues on water and sanita-
tion, energy, health, agriculture and biodiversity, highlighted by the UN
Secretary General as having been inadequately pursued at Rio and where,
for some at least, ‘time-bound targets’ were established. However, it would
be a mistake to conclude that strictly environmental questions were com-
pletely neglected, for a substantial part of the Plan of Implementation
covers ‘Protecting and managing the natural resource base of economic
and social development’ (Paras 24–46). What is also noticeable, in com-
parison to previous summit texts, is that there is a genuine attempt at con-
ceptual integration:
Unlike Agenda 21, the Plan of Implementation recognizes poverty as a running
theme, linked to its multiple dimensions from access to energy, water and sanita-
tion, to the equitable sharing of the benefits of biodiversity. This reflects a shift
from a uni-dimensional income focus on poverty to a multidimensional approach
that embraces a vision of ‘sustainable livelihoods’. (ENB, 2002, p. 170)
Other elements emphasize the magnitude of change since the heady days
of the New International Economic Order debates of the 1970s. The new
context was globalization, which had its own section (V) of the Plan and there was at the Conference extensive stress upon the opportunities pro-
vided by Type II partnerships between developing world governments and
the private sector (UN, 2002, p. 50). Nonetheless, some underlying
North–South problems continue to be identifiable in much the same form
as during the 1970s – declining and unstable developed world incomes from
commodity exports (ibid., p. 95) – and the 1980s – the unsustainable
indebtedness of many developing countries (ibid., p. 89). Following the
Millennium Development Goals and the Monterrey Consensus, WSSD
provided yet another opportunity to urge the developed states to meet the
0.7 per cent GNI aid commitment first established two years before the
Stockholm conference (ibid., p. 85).
In common with its predecessor, the WSSD relied on extensive Prep
Com discussion. There were four in all, producing a lengthy document
comprising an uneasy alignment of differing interests to be handled with
the greatest of care if the various underlying compromises were not to
come unstitched. A controversy emerging from Rio, and the long debates
over climate change, involved the principle of ‘common but differentiated
responsibilities’. This had become increasingly unacceptable to the
United States, whose delegates sought first to remove and then to limit in
application (to narrowly defined environmental issues).15 A number of
new issues spilled over from recent WTO and other meetings. They were
fought over not because binding financial and other commitments were at
stake, for the WSSD produced hardly any; but because of their symbolic
importance for the future and the sense in which they set the terms of an
emerging global bargain between North and South. At the North’s insis-
tence references to ‘good governance’ in the developing countries and the
full incorporation of developing countries in a reformed international
financial architecture pervade the WSSD text where they are regarded as
the basis for additional assistance. Closely related is the need for the South
to adopt ‘sound’ macroeconomic policies and to open their markets, par-
ticularly in the services sector. The G77 inserted text on common but
differentiated responsibilities; the crucial matter of the removal of the
developed world’s agricultural subsidies and tariffs and its continuing
obligations in terms of aid, debt relief and technology transfer.16 One
important environmental issue, arising in relation to the global trade
regime, had already been central to the long-disputed negotiations for a
Biosafety Protocol to the Convention on Biodiversity. This was the
fundamental question of the subordination of MEAs (multilateral envir-
onmental agreements) to WTO rules. Not directly a North–South issue,
it was still one that greatly exercised environmental campaigners
who feared the hegemony of neo-liberal ideas and trade promotion over
the protection of the environment. In the end textual compromises were achieved to the extent that the two should be ‘mutually supportive’ (ENB,
2002, p. 13).
5. The international politics of sustainability and the sustainability of
international politics
At first sight, much of the foregoing can be understood in classic power-
political terms. Sustainable development provided a new arena for the
pursuit and accommodation of state interests. Most of the compromises
reveal such factors at work, including the central one of the North’s
interest in environmental quality and the South’s development demands.
At a national level, a close study of any of the negotiations will reveal the
working of particularistic national and corporate interests. The G77,
for example, has had difficulty in reconciling the imminent peril of the small
island developing states (SIDS), in the face of climate change, with the
refusal of the energy exporters even to recognize the problem. At
Johannesburg the interests of energy producers on both sides of the
North–South divide prevented the emergence of any clear targets for
renewable energy (ENB, 2002, p. 7). The desire of Northern states to open
up Southern markets, often for GMOs, while protecting their own agricul-
tural producers and avoiding further public expenditure in aid commit-
ments was also evident. There was also more than a touch of national
commercial interest in the enthusiasm for Type II partnerships, which
would allow corporations to acquire Southern business in the provision of
water and sanitation.
Many of the interests pursued were not even remotely connected to
issues of sustainable development. The withdrawal of the Eastern bloc
from UNCHE in 1972 turned on the question of the status accorded to the
German Democratic Republic. At Rio there were difficulties with reference
to Israel’s occupation of Palestine, and at Johannesburg, the conflict
between the Zimbabwean and British governments.17 Organizations with
budgets and personnel to protect also have interests and the rivalries within
the thicket of UN bodies and specialized agencies are particularly intense.
Thus UNEP continues to have the rather lowly status of a programme
rather than becoming a fully-fledged organization like the FAO or the
World Bank.
It would, however, be wrong to leave it at that. Perhaps the central insight
of International Relations scholarship on international environmental co-
operation has been the significance of institutionalization that may serve to
tame and redirect the interests of states. Sustainable development has
become increasingly institutionalized in the international system. It began
with the creation of UNEP and a range of other initiatives stemming from
the Stockholm conference. At Rio, Agenda 21 called for the creation of the CSD under the UN’s Economic and Social Committee and its annual work
programme at the centre of a wider process of reviewing progress since
UNCED.18 Such institutionalization serves to keep the interplay between
economic and social development and environmental questions on the
international agenda. Thus whereas both Stockholm and Rio can be attrib-
uted to the stimulus of external events, Johannesburg was more the pro-
grammed outcome of an embedded process. Operating within a highly
institutionalized setting involving a great deal of organizational politics has
some other important consequences, which are central to an understand-
ing of the events described in this article and which must contradict any
simple ‘realist’ power politics account. The latter would predict that out-
comes would be determined by the relative military and economic strength
of state participants. While this may be part of an explanation of the situ-
ation at Johannesburg, where we might portray US hegemony challenged
by the rising economies of the South, this cannot fully account for the Rio
process. A common thread runs through the campaigns led by the G77
caucus that relied for their success upon an ability to mobilize voting
majorities in international organizations and to exploit perceived inter-
dependencies between North and South (Vogler, 2000, pp. 193–5).
How far does sustainable development actually subvert rather than
reflect normal international politics? There are two prominent questions
here for theorists of international relations. First there is a challenge to the
primacy of the sovereign state, most obviously represented in the enormous
encouragement given by the Rio process to what has been termed global
civil society. The structures that have been developed to deal with sustain-
ability issues, notably NGO participation and the Major Group system at
UNCED, certainly introduce a new element of functional representation
into the international system.19 NGO activity has been very significant in
changing agendas, in monitoring the behaviour of governments and in
operating inside government delegations (Princen and Finger, 1994;
Willetts, 1996; Newell, 2000). There is most certainly now a ‘mixed actor
situation’, but this does not necessarily amount to a fundamental subver-
sion of the system where sovereignty over natural resources continues to be
jealously guarded and where state participants in the Rio process are
careful to insert ‘intergovernmental’ into the title of many of the key organ-
izations. A salient characteristic of the Johannesburg WSSD was not only
the number of NGOs involved but their rising alarm at the prominence of
another, more powerful, type of non-state actor – the transnational busi-
ness corporation. The extent to which states can regulate the activities of
the corporate sector is just one part of a lively debate about the possibility
and desirability of state action for sustainability under conditions of glob-
alization (Barry and Eckersley, 2005).
Rather than considering how the international political system, as pre-
sently constituted, can manage the problems of sustainability, some
analysts have taken a more radical stance. For them, the sustainable devel-
opment agenda is indicative of a deeper crisis in global social ecology
which must prompt questions that are inherently subversive of the current
political order (Sachs, 1993; Saurin, 1996; Paterson, 2001). It challenges
the ‘issue hierarchy’, the dominance of the international trade regime and
indeed the whole apparatus of globalization that serves the interests of
capital accumulation and mass consumption societies. Since the failure of
the NIEO, North–South dialogue on environment and development has
essentially failed to engage the underlying pathologies of the global system
as both Northern and Southern states pursue their short-sighted interests
within a neo-liberal consensus. Thus the international politics of sustain-
able development represents at best a distraction and at worst an obstacle
to human survival. Endless conferences and diplomacy (which themselves
have major ecological costs in terms of air-miles travelled and paper
consumed) merely give the impression that something is being done, while
reinforcing the underlying structures of the global political economy.
From this perspective the urgent question does not concern the interna-
tional politics of sustainable development, but the sustainability of inter-
national politics itself.

27 Financing for sustainable development David Pearce

1. The issue
Does the pursuit of sustainable development require special financing?
Achieving sustainable development is about policy measures that alter
human behaviour towards the environment and towards society in general.
Behavioural change could be achieved in various ways and some of those
do not necessarily involve any financial flows. For example, moral suasion –
the process of awareness raising and encouraging moral behaviour – need
not involve any finance, although it may involve non-monetary costs to
those changing their behaviour. The argument from moral suasion is self-
fulfilling: if we all behaved ‘sustainably’ the world would have a better
chance of being sustainable. The problem, as is well known, is that humans
are complex mixtures of selfish and altruistic behaviour and simply appeal-
ing to the altruistic aspects of behaviour frequently fails to achieve goals
that might be considered to be consistent with sustainability. Simply put,
humans are not altruistic enough. In other cases, for example in its part in
combating racism, suasion has arguably worked quite well. But acknow-
ledgement of the difficulties of suasion leads to the second approach to sus-
tainability, one based on coercive laws which ban or regulate adverse
behaviour and perhaps reward good behaviour. Such laws also need not
have any financial flows associated with them. By and large, this approach
to sustainability characterizes most environmental and social policy. Such
laws have worked fairly well in many cases. But economists and political
scientists have repeatedly warned of the dangers in the direct regulatory
First, regulations, and especially bans, frequently create economic rents
which result in rent-seeking, rent capture and corruption, essentially
unproductive activities which detract from potential human well-being.
Activity shifts from creating human well-being to securing as large a part
as possible of the financial gains associated with restrictions. Second, reg-
ulation can be expensive, with the result that coalitions are formed to prevent
or water down further regulations. Third, regulations, especially those
formed at the international level, frequently achieve no more than would
have happened without the regulation: they lack ‘additionality’ (Barrett,
2003). This is because of the essentially game-theoretic nature of such
agreements whereby no one agent is going to agree to harm themselves for the overall common good. Hence what they agree to is what they would
have done anyway, with their participation and agreement being hailed in
rhetorical terms. Regulations can of course be associated with some finan-
cial flows: fines for non-compliance would be an obvious example. But, by
and large, regulation works, when it does work, by threat, where the threat
is criminal or civil liability.
No one suggests that suasion and direct regulation have no role to play
in the pursuit of sustainability, but there is an increasing interest in policy
mechanisms that do involve financial flows. In the market place for private
goods the role of finance is obvious. The seller of a good (or service) parts
with that good to a buyer in return for a cash flow from the buyer to the
seller. Finance for publicly provided (public) goods is more indirect. Public
goods are goods which when provided to one person tend to be provided to
a larger group, with few prospects of excluding any individual in that group.
In the same vein, public goods are difficult to appropriate, that is to charge
prices according to use. The provider or supplier of public goods is usually
the government or the agent of the government, and beneficiaries do not
pay directly for the good but indirectly via their taxation. The taxes paid
may not be linked directly to the benefits – that is the financing of the public
good comes out of general taxation. More recently, there has been a
growing interest in linking tax payments more directly to the public good
through ‘hypothecation’ or ‘earmarking’. One justification for hypotheca-
tion comes from the public choice literature which argues that taxpayers
will be more content to pay for public goods if they can trace the ways in
which their payments translate into public good provision.
All of this is familiar. The problem is what to do with the very large
variety of non-market goods, many of which have public good character-
istics, for which there are no markets and for which public provision may
not exist or, if it exists, may not work efficiently. It is this class of goods and
services that we focus on in this chapter. Examples are well known: reduced
global warming, avoided biodiversity loss, cleaner water and air, protected
areas where public finance is insufficient, and so on.
2. Financial flows and the Coase theorem
A financial flow involves an exchange of cash or in-kind benefits between
three agents in the economy: the individual, corporation or agency gener-
ating environmental and/or social harm; the agent suffering the harm;
and the regulator or government. For simplicity, let us call these agents
‘the polluter’, ‘the sufferer’ and ‘the regulator’. By definition, the sufferer
becomes a beneficiary if the polluter ceases to pollute. Hence we will
also speak of ‘beneficiaries’. As Coase (1960) made clear, polluters or
sufferers/beneficiaries may hold the property rights. If polluters hold the rights then sufferers should be able to pay polluters not to pollute and it will
be in their self-interest to do this so long as the marginal damage they suffer
exceeds the payment they make for a marginal reduction in pollution. In
turn, the polluter’s self-interest is served if the received payment exceeds the
marginal benefit he/she would have made from the damaging activity. If the
sufferer holds the property rights, then the polluter cannot pollute unless
he/she pays the sufferer compensation that exceeds the damage done.
Figure 27.1 shows the familiar Coasian bargain diagram.
The horizontal axis shows pollution (for which read resource degrada-
tion, social harm and so on). MNPB measures the marginal net private
benefits to the polluter from the activity creating the pollution. To fix ideas,
it is simplest to construe MNPB as marginal profits. Then, if the polluter
holds the property rights, he/she will operate at Qpriv where total profits A +
B + C are maximized, unless induced to do otherwise. MD shows the mar-
ginal damage suffered by the sufferer. MD can also be defined as the mar-
ginal external cost arising from the polluter’s activity. At Qpriv the sufferer
bears a cost of B + C + D. It is immediately obvious that there are gains to
be made by some sort of bargain. Total social welfare at Qpriv is the
difference between profits and suffering, that is A D. But if a move to Q*
could be engineered, net social welfare would be A B B = A. Given the
property rights rest with the polluter, the sufferer can pay any sum less than
C + D to induce the polluter to surrender profits associated with activity
level Qpriv. Exactly what is paid depends on the relative bargaining strengths
of the parties in question.
The reader can determine that exactly the same result holds if the sufferer
has the property rights. In this case, the starting point is the origin and payments less than A + B, but more than B, will compensate the sufferer
for tolerating pollution. Either way, the optimum Q* is achieved and the
achievement comes about without the interference of the third agent, the
regulator. For those who believe in the optimality of free markets,
the Coase theorem is a justification for the minimal role of regulation and
the government. Note that the problem of the optimal provision of non-
market goods has been solved with a flow of finance: either compensation
flows from polluter to sufferer, or payment (sometimes misleadingly called
a ‘bribe’ in the literature) flows from sufferer to polluter. It is this financial
flow that secures optimality in the sense of economic efficiency.
Economic efficiency is not necessarily the same thing as sustainability,
since that depends on the notion of sustainability adhered to (see Chapters
4 and 6 for a discussion). If it is weak sustainability, in which there is substi-
tution at the margin between environmental, social and man-made assets,
then economic efficiency is sustainability. If it is strong sustainability, which
subsumes weak sustainability but has the added constraint that environ-
mental assets must not (in some sense) decline, then this goal appears to be
achieved if the polluter has the property rights, but not if the sufferer has the
property rights. The reason for this is that pollution is reduced (which is the
same as saying environmental assets increase) in the former case, but it is
increased in the latter case. The starting point matters. But since strong sus-
tainability denies the substitutability of compensation and environmental
assets, it would effectively rule out the polluter paying compensation to the
sufferer for an increase in pollution. (There would have to be some form of
regulation that would deny the polluter paying compensation. In practice,
such payments are not uncommon, for example with airport noise compen-
sation.) Strong sustainability therefore involves an efficiency loss equal to
area A in Figure 27.1. This is not surprising since it involves an added con-
straint on the maximization of social welfare. But the nature and existence
of this efficiency loss is not always made clear in the sustainability literature.
The Coase theorem generates financial flows which act to secure sustain-
ability in the weak sense. The theorem simply does not operate with strong
sustainability and if sufferers have property rights to zero pollution – no
bargain involving compensation for suffering would be permitted. If
polluters have the property rights, then strong sustainability would presum-
ably still sanction a move like the one from Qpriv to Q* in Figure 27.1 since
it is (a) efficient and (b) reduces pollution.
While theoretically elegant, the Coase theorem is in fact very problem-
atic when efforts are made to transfer it to the real world. As such, the finan-
cial flows likely to be involved in actual bargains over non-market goods
will be more complex than simple ‘polluter pays sufferer’ or ‘beneficiary
pays polluter’.
First, the trades involve transactions costs. Indeed, many regard the most
restrictive condition in the Coase theorem to be that bargaining is costless.
In reality, we know that transactions costs are very important in actual bar-
gains. This immediately suggests a role for the regulator (government), pro-
vided regulatory costs do not outweigh the gains from trade, something
that cannot be guaranteed. Regulation here would typically mean ‘facili-
tating’ the bargain by actions which directly reduce transactions costs (for
example regulators may have more access to information about polluters or
sufferers than do the parties themselves – an obverse of the usual assump-
tion about asymmetric information), or by the regulator taking over the
bargain on behalf of one of the parties.
Second, Coasian bargains are indifferent to equity concerns – the
theorem is about efficiency alone. But governments and regulators are
highly likely to have equity concerns. Interestingly, these concerns are not
confined to contexts in which the sufferer is poor. They may arise where
either the sufferer is poor or the polluter is poor. In the former case,
government may take on the role of acting for the poor sufferer. This is the
case with the Costa Rican ecosystem service payments whereby govern-
ment pays upland forest owners not to deforest because of the otherwise
detrimental effect on poor downstream farmers (for a discussion, see
Pearce, 2004). The government effectively acts for downstream beneficiaries
of upstream forest conservation and the presumption is that many of these
beneficiaries are relatively poor and could not pay for beneficial conserva-
tion. The limitation of the Coase theorem in this context is that it assumes
the availability of a financial fund in the hands of the sufferer. However
economically rational payment to the polluter would be, if the financial
resources are not there payment cannot be made. The standard response to
this issue is that inability to pay is the same thing as unwillingness to pay,
since willingness to pay is always constrained by income. True as that may
be, the issue of unfairness remains. In such contexts, governments may well
become the agents for the poorer party. The flow of finance thus becomes
more complex. In the Costa Rican case, for example, the financial flows
arise from a tax on vehicle pollution, the flows then being used to finance
payments to upland forest owners, without any form of financial flow
affecting the sufferer.
The case where the polluter is poor is less obvious, but a striking example
is the technical and financial assistance given by Scandinavian countries to
Baltic countries to switch energy-generating technologies away from high
polluting to less polluting ones. The benefit to Scandinavia is the reduced
transboundary acid rain deposition that results. As long as Scandinavian
payments are less than the value of the avoided damage, Scandinavia is
better off. As long as the incremental cost of the cleaner technology is zero or negative to the Baltic States, they are better off. Here the sufferer is
paying the polluter. Nakada and Pearce (1999) have shown that the same
principle would be efficient for transboundary pollution from China to
Third, non-market goods tend to have the features of public goods. As
such, in the case of pollution control there tend to be many beneficiaries
ranging from a local population to the world as a whole. The Coasian solu-
tion would be for these populations to form a coalition to bargain with the
polluter. This is exactly what does happen in a number of cases, notably
with the Global Environment Facility (GEF) which bargains with devel-
oping and transition countries to change polluting technologies to less pol-
luting ones or to conserve biodiversity that might not be preserved in the
local national interest. As a United Nations agency, the GEF receives
finance from individual subscriber nations so that taxpayers in those coun-
tries first pay the GEF for onward payments to recipient nations to change
their technology and conservation choices. Theoretically, the payments
equal or just exceed the ‘incremental cost’ to the host nation of making the
switch to the globally beneficial technology or policy. The GEF is a prime
example of ‘market creation’ whereby beneficiaries pay polluters who hold
the (in this case, sovereign nation) property rights.
The fourth problem with the Coase theorem is that it assumes one of the
two bargaining parties already has the property rights. In practice, many
environmental problems involve ill-defined or even non-existent property
rights. In the extreme, the case of no property rights is equivalent to ‘open
access’ conditions. As is well known from the bioeconomics literature, open
access produces an equilibrium in which all rents are dissipated. The equi-
librium may be stable but is easily perturbed to produce situations of total
resource loss (extinction). This will happen if technological change in
resource harvesting (guns as opposed to spears in the case of large
mammals, refrigerated ships and industrial trawl methods in the case of
fish, and so on) reduces the cost of harvesting to the point where the equi-
librium goes beyond some sustainability threshold. The massive problem of
global over-fishing arises precisely from open access combined with new
technology and rising demand.
The Coasian response to open access contexts is, correctly, to establish prop-
erty rights. In many respects this is how the institutions related to natural
resources and the environment are developing. The UN Framework
Convention on Climate Change and the Convention on Biological Diversity
are examples of attempts to establish either global communal rights to the
atmosphere (global warming) or some form of attenuation of existing
sovereign rights to biodiversity, but these rights mask the effective open-access
nature of the resources within those sovereign states. Notably, in both cases, global beneficiaries pay the poorer parties to reduce pollution or resource loss.
In the global warming case this is effected through two of the ‘flexibility mech-
anisms’ of the Kyoto Protocol – the Clean Development Mechanism and Joint
Implementation. In the biodiversity case, richer countries are supposed to pay
poorer countries for access to their resources and to share the benefits. In both
cases, finance flows from rich to poor or poorer.
Overall, then, the Coasian paradigm is a useful starting point for
analysing financial flows. When the theorem works in its original form, the
financial flows are from beneficiary to polluter or from polluter to benefi-
ciary, depending on which owns the property rights. Once it is accepted
that the kinds of goods and services in the environmental context are
public goods, then the way is open for a significant modification of the
theorem whereby governments or regulators act as intermediaries. In this
case they may collect pollution taxes or charges for onwards payment to
sufferers, or they may retain the proceeds in general funds. Where polluters
have the property rights, governments may act to finance the necessary
payments to polluters. Finally, no flows of finance occur in the open access
case where no one has defined property rights. Indeed, it is precisely
because there are no financial flows that open access risks securing equi-
libria that are easily ‘tipped’ into states of extinction, as the examples of
over-fishing show. The Coasian solution is to establish property rights in
order to facilitate some form of bargaining or exclusion. Another way of
viewing this is that the establishment of property rights permits flows of
finance to occur, with all the relevant incentives for securing optimality
now being enabled.
Financial flows: a review of the issues
Focusing financial flows on developing countries
Recent advances in wealth accounting indicate that the conditions for sus-
tainability centre round the notion of increasing stocks of overall per capita
wealth (see Chapter 19). In turn, wealth comprises a broad spectrum of
assets – conventional man-made capital, human capital, social capital and
environmental (natural) capital. Preliminary wealth accounts indicate that
it cannot be taken for granted that rich countries pursue paths of develop-
ment that obey the fundamental ‘rising per capita wealth’ rule (Hamilton,
2000; Hamilton and Clemens, 1999). Nonetheless, by far the largest pro-
portion of countries that fail to meet the rule are developing economies. In
what follows we assume that the focus should be on correcting non-
sustainability in the developing world, and hence the focus should also be
on financial flows to developing countries, or on changing financial flows
that currently harm poor countries’ prospects for sustainability.
Reducing damaging financial flows: subsidies
One approach to financing sustainability that commands wide assent, and
which appears to be ‘win–win’, is the redirection of existing financial flows
that are both inimical to economic efficiency, narrowly construed, and to
environmental progress. Subsidies to inputs and outputs both appear in this
category and a substantial literature has grown up on the issue (for example
van Beers and de Moor, 2001; Porter, 2002; Michaelis, 1996; OECD, 1996;
1997; 1998; Milazzo, 1998). The basic argument is that subsidies involve
deadweight losses of well-being regardless of any environmental effects.
Once the latter are brought into consideration, the scale of the combined
inefficiency can be substantial. Moreover, a growing part of the subsidy
literature draws attention to the fact that subsidies often do not, contrary
to initial expectations, benefit the poor. Even when targeted at the poor,
middle income groups tend to manipulate the subsidy system so that it
benefits them. This should hardly occasion surprise once it is recognized
that, like many regulations, subsidies create rents and hence a whole ‘indus-
try’ emerges which seeks to capture the rents (see also Chapters 13 and 14).
It is more likely that the powerful will capture the rents, further marginal-
izing the poor. Subsidies therefore have an equity dimension as well as an
efficiency dimension.
Van Beers and de Moor suggest that, globally, subsidies to inputs and
outputs, especially in agriculture, energy, water and fisheries may amount
to just over $1 trillion annually. Nearly 70 per cent of these subsidies are in
OECD countries. Perhaps the most startling figure is that agricultural sub-
sidies in OECD countries account for over 30 per cent of entire world sub-
sidies. From the standpoint of sustainability these subsidies can be thought
of as highly damaging financial flows that finance non-sustainability. Not
only do subsidies in OECD countries harm the environment in OECD
countries, but Anderson et al. (2000) have simulated the effects of remov-
ing rich countries’ tariff and non-tariff barriers to developing country
exports. While it is true that developing countries face even larger barriers
from protectionist policies in other developing countries, rich country pro-
tection costs the developing world over $100 billion annually.
It is hardly surprising therefore that those seeking finance for sustain-
able development should target subsidies since they appear to damage rich
country environments and also damage the growth potential of poor
countries by restricting and denying them markets. Subsidies within devel-
oping countries can often absorb significant fractions of public expend-
iture, further precluding the provision of genuine public goods in those
countries. Subsidies also deny the ability of public utilities any chance to
finance their own investment programmes since revenues systematically
tend to fall short of costs of provision. Pearce (2002) also notes hitherto neglected effects, for example subsidies in the rich and poor world encour-
age resource depletion and environmental damage that harms the well-
being of the poor by depleting their human capital through ill-health.
Water shortages, water pollution, deforestation are all examples of this
indirect link. Some idea of the potential for financing is that current
annual subsidies are some 16–17 times the annual flow of official develop-
ment aid to developing countries.
But how realistic is it to expect diversion of existing subsidies into pro-
jects and policies consistent with sustainability? The truth is that removing
subsidies involves losers, and hence such policies cannot be described as
‘win–win’. The problem is that the losers are those with the vested interest
in the subsidy regime continuing and even expanding. Since those interests
are, ex hypothesi, those with the power to capture the rents arising from
subsidy regimes, it follows that removing subsidies is far from easy. Pearce
and Finck von Finckenstein (1999) survey the various conditions under
which subsidy regimes might be radically altered. These include careful
timing of announcements to avoid likely political coalitions objecting to
the changes and even undertaking the changes during periods of major
political upheaval. But many of the efforts have been quite subtle, for
example retaining a subsidy on a good that is purchased by rich and poor
alike but differentiating the product so that the rich come to perceive it as
Reducing damaging financial flows: debt repayments
Forgiving debt repayments has become an integral part of overseas aid
regimes in the last decade or so. The links to sustainable development are
twofold. First, debt repayments come from public funds that could other-
wise be used for the provision of public goods in the indebted country.
Hence investment in for example education and health suffers. Second, debt
repayments have to be in hard currencies, which means that the indebted
country has to earn foreign exchange. This it may do by focusing on export-
ing natural resources, such as timber, in an unsustainable manner. As far as
deforestation is concerned, the second of these linkages has been investi-
gated in two major meta studies, Kaimowitz and Angelsen (1998) and Geist
and Lambin (2001). Neither finds an unambiguous link between debt and
deforestation, while Geist and Lambin regard the link as being very weak.
This suggests that debt-forgiveness is unlikely to have any significant effect.
Strand (1995) sets out a theoretical model in which exactly this result
emerges when debt forgiveness is not backed up by conditionality.
Whatever the benefits of debt forgiveness, they are likely to show up more
in the increased flexibility of public expenditures generally rather than in
natural resource damage.
Increasing financial flows: official foreign aid
Whereas direct private investment flows from rich to poor countries will
generally be guided by market rates of return, and therefore have their jus-
tification in terms of conventional commercial criteria, official aid flows are
more directed at the provision of public goods and services. As noted above,
these public goods are integral to sustainability, including as they do infra-
structure, water, education, health, power generation and the environment.
Calls for increased foreign aid from donor countries (the OECD ‘Develop-
ment Assistance Committee’ (DAC) countries) have been long-standing.
Currently, only five nations exceed the United Nation’s target of 0.7 per
cent of donor GNP. Net Overseas Development Assistance (ODA) has
risen in real absolute terms to some US$60 billion in 2002–03 (2002 prices),
but compared to 1992–93 shows only a 5 per cent increase. The United
States’ share of ODA has fallen from 30 per cent in 1982–83 to 23 per cent
in 2002–03, the absolute real amount of US aid being approximately con-
stant over that 20-year period ( The 0.7 per cent
target, if it was met overnight, would increase flows from some $69 billion
in 2003 to over $190 billion. Note that the implied increased scale ($130
billion) is similar to the $100 billion adverse flows arising from rich country
protection policies.
Apart from moral arguments, increasing official aid has its justification
in the potential role of official aid in increasing the provision of public
goods in developing countries. The caveat is that the aid should be effective
and here there is a further debate with claims and counter-claims about the
extent to which even existing aid flows, let alone increased ones, contribute
to development goals. Collier and Dollar (2001) conclude that aid may well
be ineffective if it is not accompanied by ‘good’ policies. Once the appro-
priate policies are in place, however, both the rate of return to those poli-
cies and the effectiveness of aid is increased. The policy reforms involved in
this assessment are those that tend not to be supported by the NGO com-
munity: macroeconomic stability and trade openness, but few would argue
that the rule of law strongly influences development potential.
Increasing financial flows: looking for deep pockets
Whereas the debate over official aid focuses on both the donor ability to pay
and the recipient’s ability to utilize funds, the NGO community has tar-
geted what might be called the ‘supply side only’ approach by looking for
sources of ‘mega-funds’. The object here is to find a tax base that could be
subject to a very modest tax rate but with the capability to yield potentially
large revenues. Currency dealings have been targeted, invoking, perhaps
somewhat unfortunately, Nobel prize-winner James Tobin’s name in the
form of a ‘Tobin tax’. Tobin was concerned with a tax to assist currency market instability. The NGO Tobin tax proposal is simply a source of
revenue. To make the tax palatable to the financial markets, the suggestion
by the Stamp Out Poverty campaign, an alliance of NGOs formed in 2005,
is for a very modest tax rate per currency transaction. Since annual foreign
exchange transactions are of the order of $250 trillion per annum, it is easy
to see that even small tax rates would raise large sums of money. The prob-
lems with these kinds of financing proposals are many. Apart from the low
likelihood of implementation and the high transactions costs, the tax is
divorced from activities that contribute to non-sustainability. Currency
transactions are either counterparts to real transactions which are likely
already to attract an element of externality tax, or they are designed for
arbitrage and a smooth functioning of financial markets. There is no
obvious link to activities detrimental to sustainability and hence no link to
the polluter pays principle. In short, it is hard to argue that foreign
exchange transactions contribute to non-sustainability. Indeed, the oppo-
site would appear to be the case. If so, the ‘Tobin tax’ becomes a tax on sus-
tainable development, not a tax to deliver sustainability.
4. Market creation: paying for environmental services
The start of this chapter indicated that the creation of markets in currently
non-market goods and services generates a flow of finance that mimics the
financial flows for market goods. The differences are likely to be that the
goods and services provided will have significant public good characteris-
tics. Those paying for the services are therefore going to be governments or
government agencies, or organizations with altruistic goals. This indeed is
how this form of market creation has evolved. Since there is now a huge
number of such initiatives, only a few of the more important examples can
be provided. Reviews of many of the transactions can be found in Daily
(1997), Pagiola et al. (2002), Swingeland (2003), Pearce (2004) and Scherr
et al. (2004).
Debt-for-nature swaps
‘Debt-for-nature’ swaps (DfNSs) began in the late 1980s and continue to
this day, although the parties involved tend to have changed over the years.
They are essentially Coasian, in that an agent concerned to secure environ-
mental conservation or some form of human capital investment buys sec-
ondary international debt denominated in hard currencies and offers to
cancel or convert it in exchange for the good or service in question. Thus,
an NGO or a government might convert debt from a forested country in
return for conservation of the forests. Other swaps have related to educa-
tion and health initiatives, but most are linked to environmental products
and services.
All swaps are confined to commercial debt – debts owed to private
lenders such as commercial banks – and official bilateral debt, that is debt
owed to foreign governments. No multilateral debt (for example World
Bank loans) is involved in the swaps, which has limited the prospects for
developing this instrument. Bilateral debt deals tend to operate through the
Paris Club, a group of bilateral lenders dedicated to reducing and convert-
ing debt that threatens poor country development. In 1990, the Paris Club
agreed to allow a considerable portion of international debt to be dealt with
via debt-for-development swaps. In the event, only a limited number of
creditor countries have operated such schemes.
Some of the most celebrated debt swaps involving governments and
NGOs are those under the Enterprise for the Americas Initiative (EfAI),
established in 1990. The debt in question is owed by Latin American and
Caribbean countries to the USA. The US Tropical Forest Conservation
Act (TFCA) of 1998 enabled further expansions of the EfAI, permitting
debt reductions against forest conservation. From 1991 to 1993 EfAI
conversions amounted to $875 million face value, creating local trust
funds in seven Latin American/Caribbean countries of $154 million. The
TFCA has provision for $325 million of funding. Another significant
government player in DFNSs is Switzerland, which set up a Swiss Debt
Reduction Facility in 1991. The Swiss programme involves several forms
of conditionality: there must be economic reform in the indebted
country, there must be rule of law, and there must be a general debt
reduction programme in the country in question. The Swiss deals have
involved some $460 million face value debt or over $160 million of
redemption value and investment funds (leverage appears to be zero on
the Swiss deals).
Pearce (2004) shows that, to 2003, DfNSs amounted to some $5 billion
when measured in terms of the face value of the debt, and just over
$1 billion when measured at the purchase price. These figures are heavily
influenced by one ‘package deal’ with Poland with a discounted value of
nearly $600 million. But the sums are also leveraged as other investors
piggy-back on the DfNSs. This raises the total value by some $2 billion.
DfNSs are attractive to the indebted country since they reduce foreign
exchange commitments, albeit for attenuated sovereignty over some natural
resources. They are attractive to NGOs since they involve modest costs for
potentially large scale conservation – costs per hectare of land conserved
appear to be no more than a few dollars – and because they meet NGO
goals of providing public environmental goods at the global level. They are
also attractive to donor governments who are faced with pressures for debt
forgiveness. DfNSs permit a kind of ‘forgiveness with conditions’, but with
the conditions being generally benevolent.
The Global Environment Facility
The Global Environment Facility (GEF) was established in 1990 in a ‘Pilot
Phase’, or GEF I, which lasted from 1991 to 1994. It is a United Nations
Agency which functions by donations from OECD countries and a few
non-OECD countries. Its initial activities were unrelated to any interna-
tional environmental conventions other than the Montreal Protocol on
ozone layer depletion. Its coverage was biodiversity, climate change, ozone
layer depletion and, curiously, ‘international waters’ – seas and lakes shared
by two or more nations. But the GEF soon took on the official role of being
the financing mechanism for the Framework Convention on Climate
Change (1992), the Convention on Biological Diversity (1992), the
Stockholm Treaty on Persistent Organic Pollutants and the Convention to
Combat Desertification. The implementing agencies were initially the
World Bank (WB), United Nations Environment Programme (UNEP) and
the United Nations Development Programme (UNDP), with various other
agencies being given similar powers later on.
The basic idea of the GEF is that it should assist in financing activities
in the developing countries and the economies in transition that would be
of benefit to the global community but which the relevant countries would
not undertake as part of their normal development activities. Put another
way, the GEF seeks to internalize the ‘global externality’ arising from devel-
opment activity. An example might be a coal-fired power plant that a devel-
oping country considers the cheapest option for meeting extra power
demand. Coal has a high carbon content so contributes significantly to
global warming. The role of the GEF would be to investigate alternatives
to coal – for example natural gas, energy efficiency, or even renewable
energy. Since, ex hypothesi, coal is the cheapest option, the developing
country needs an inducement to take on the additional or ‘incremental’
cost. By paying this incremental cost, the GEF secures the global benefit it
was set up to secure. While the notion of incremental cost is meaningful for
climate change, it is less obvious how it would be calculated in the context
of biodiversity conservation. Incremental cost would have to be compared
to a hypothetical baseline of what the host country would have done
without the GEF’s intervention. Host countries have an incentive to say
they would have done nothing so that the full cost of conservation is met
by the GEF.
The parallel with a Coasian bargain is obvious. Developing countries
have sovereign rights to use their natural resources as they see fit, but the
world as a whole has an interest in, and would benefit from, their conser-
vation. The ‘polluter pays’ principle fails because of the global pervasive-
ness of the externalities, sovereign rights, and the poverty of the polluters.
Hence, the ‘beneficiary pays’ principle is invoked. It can be seen that the GEF is ‘Coasian’ in style, but because it seeks to provide global public
goods, beneficiaries do not bargain with those who own the property rights.
Rather, an international agency representing governments bargains on
their behalf. As with DfNSs, various forms of co-financing occur, with the
ratio being approximately 2:1 in favour of the other forms of finance. The
extent to which this co-finance is ‘additional’, that is is not taken from
financial flows for other development or conservation purposes can only be
guessed at.
Table 27.1 suggests that GEF expenditures have been running at about
$1 billion p.a. across all target areas, with around 60 per cent of expendi-
tures being for climate change control.
The GEF and DfNSs exemplify the ‘beneficiary pays’ market creation
approach. How far the associated financial flows are additional is
unknown – there is some suspicion that some part of the official DfNSs
and some part of the GEF expenditure is being met by diverting other
overseas development assistance. However, both are examples of innova-
tive global market creation. Both also operate in a ‘bottom up’ mode with
outcomes being determined on a project-by-project basis. Moreover, the
skills and experience generated by these deals has direct application to the
development of other financial instruments for sustainable development,
as we see shortly. These global examples are matched by a multitude of
one-off deals in which, say, a conservation agency in the USA or Europe
will pay for conservation in an area of a developing country. In some
cases, notably in Costa Rica, an imaginative package of deals has been
developed ranging from payments for forest conservation, through to
carbon offsets and bio-prospecting (paying for genetic information from
forests for example). The Costa Rican experience has attracted extensive commentary – see for example Chomitz et al. (1998) and Rojas and
Aylward (2003).
5. Market creation: new financial instruments
One of the most interesting developments in sustainability financing has
come with the development of new financial instruments to cover environ-
mental risks or environment-related risks. These risks can be ‘natural’, for
example changes in the weather, or they can be induced by regulation. An
example of the latter would be a limit, or ‘cap’, set on greenhouse gas emis-
sions in the name of global warming control. Such aggregate caps are then
assigned in some way to those who emit the greenhouse gases. What is
needed then is a market in the emission credits or debits that arise from,
respectively, over-achieving and under-achieving an emission target. A sec-
ondary market arises which trades claims in emission reduction.
A variant on regulation-induced markets are self-regulatory markets
where the emission reduction is self-imposed either out of altruism or, more
generally, because corporate performance is socially rated according to
some environmental and social performance index. It may pay corpora-
tions to adopt ‘corporate social responsibility’ (CSR) targets in order to
have a higher social profile consistent with long term profits and the general
avoidance of bad publicity. Legal liability for environmental pollution
obviously does have an impact on corporate asset values. It is less obvious
that legal pollution has such an impact, the literature being ambiguous
because of poorly designed studies and advocacy rather than rigorous
analysis. A study by Konar and Cohen (2001) for the USA does suggest that
legal pollution may impose an intangible asset liability of around 10 per
cent of the replacement value of tangible assets.
Weather derivatives and ‘catastrophe (CAT) bonds’ are examples of
financial instruments that emerged in the 1990s to cope with natural climate
variability. Weather derivatives began in 1997 in the USA and are financial
contracts for protection of revenues in face of uncertainty about the
weather. They are akin to insurance but with the difference that payout is
triggered by the weather condition rather than by any proof of loss on the
part of the insured. Self-evidently, weather derivatives began life mainly in
the context of the energy sector where seasonal peaks and troughs of
demand have considerable impacts on energy providers. But demand from
recreational activities such as sports has also grown.
CAT bonds have a similar function, but in this case to insure against
natural disasters such as earthquakes, storms, hurricanes and so on. Where
this was once the province of insurance and reinsurance, some catastrophes
in the late 1990s produced financial losses that outstripped the capacity of
the insurance market. Insurers turned to the capital market. CAT bonds attract investors who are keen to act like reinsurers, securing returns well
above money-market yields against a default risk (the risk that the cata-
strophic event will happen) several times lower than this. By buying bonds
diversified across risks that are uncorrelated, the investor obtains consider-
able security. Moreover, CAT bonds are unaffected by the normal varia-
tions in financial markets – only the natural event risks matter. A secondary
market has also begun to emerge, that is the bonds themselves are traded.
The relevance of these financial instruments to sustainable development
may appear limited. But what these instruments are demonstrating is that
financial markets can and do adapt to the changing nature of risks. In so
far as disasters are threats to sustainability, these financial instruments have
a role to play in ensuring that catastrophes do not bring about social col-
lapse in the face of no insurance. Moreover, some catastrophes of the kind
covered by the CAT bond market may increase with global warming, so
that the market effectively adapts to the variable damage that warming is
likely to bring.
The development of a derivatives market in greenhouse gas emission
reduction is better known outside as well as inside financial market circles.
The first carbon offsets or ‘joint implementation’ (JI) projects began in the
USA in the late 1980s. Those deals were voluntary, that is they did not
reflect any requirement to comply with a regulation, national or interna-
tional. In the very first deal, Applied Energy Services invested in carbon
sequestration in Guatemala, and there was no regulatory requirement to
offset its own carbon emissions. The deal involved sequestering or reducing
emissions of carbon dioxide outside of the own source of emissions. If
there is a regulatory obligation to cut emissions the motivation for the trade
would be that it is cheaper to cut emissions or sequester carbon through the
trade rather than ‘at home’. In a voluntary context, the motivations were
primarily good corporate image and learning how the market would
operate. Later trades in the 1990s were undertaken with the aim of antici-
pating Kyoto Protocol targets, but there was also some effort to ‘capture’
the regulatory process by showing forward commitment.
Joint implementation involves bilateral trades: the investor pays for
reductions in emissions compared to some baseline in another location, but
secures the credit for emissions reduction. ‘Activities Implemented Jointly’
was initiated in 1995 by Conference of Parties to the Framework
Convention on Climate Change with the explicit aim of learning how joint
implementation would work. Joint implementation between rich and poor
countries was enabled in the 1992 Framework Convention on Climate
Change but projects could not secure credits against the 2008/10 Kyoto
Protocol targets. A significant number of the joint implementation projects
came from the US ‘Initiative on Joint Implementation’ (USIJI) begun by the Clinton Administration in 1993. USIJI was originally designed to help
the USA secure its Rio voluntary target of returning to 1990 emissions by
2000. The US had ratified the Framework Convention in 1994. The USIJI
projects range across energy conservation, energy production (mainly
switching to lower carbon energy sources in power generation), and carbon
sequestration in biomass.
Notable host countries included Costa Rica, where the benefits of being
a carbon trade host were recognized early on, Russia and Mexico. Various
other initiatives were announced. Notable among the leaders were the
Dutch Government’s ERUPT programme (Emission Reduction Unit
Procurement Tender), some programmes in Canada, Oregon, and the World
Bank’s Prototype Carbon Fund.
With the advent of the Kyoto Protocol, negotiated in 1997 and brought
into force in 2005, three forms of greenhouse gas trading, or ‘flexibility
mechanisms’, emerged:
Article 6 of the Protocol enables Annex 1 countries (basically OECD
plus transition countries) to trade among themselves to secure emis-
sion reduction units (ERUs). Trades cover emission sources, such as
burning fossil fuels, and so-called ‘sinks’. Sinks refer to the growing
of biomass (trees and other vegetation) which absorbs, or ‘fixes’,
carbon dioxide from the atmosphere at a faster rate than it emits it.
These trades must be additional, that is over and above what would
have happened without the project, and must be supplemental to
domestic actions, implying that, despite trading, the emphasis must
be on domestic reduction activities. Article 6 carbon trading is known
as ‘joint implementation’ and is project-based. The private sector may
participate in such trades if approved by the relevant government.
Article 17 states that Parties listed in Annex B (that is countries with
mandatory quantitative targets under the Protocol) ‘may participate
in emissions trading’ but, again, such trading shall be ‘supplemental
to domestic actions’ to meet stated targets. The units of this trade are
assigned amount units (AAUs). Several proposals emerged for the
establishment of an allowance trading system – for example by the
governments of Australia, Canada, Iceland, Japan, New Zealand,
Norway, Russia and the USA (before withdrawal). Article 17 carbon
trading is known as ‘emissions trading’ or allowance trading.
Article 12 defines a Clean Development Mechanism (CDM) which
involves Annex 1 countries (who have legally binding obligations)
trading with non-Annex 1 countries, that is those without any oblig-
ations. Whilst virtually identical with joint implementation, the
CDM establishes a principle of self-interest from the developing countries’ point of view, namely that trades must contribute to
their sustainable development. The Protocol is silent on the meaning
of the term ‘sustainable development’. The units of credit under the
CDM are ‘certified emission reductions’ (CERs). The CDM is
A fourth form of trading arises for collective targets of which the prime
example is the European Union (EU) collective target. The EU emissions
trading scheme sets a ‘bubble’ over the Europen Union such that EU
member states can trade within that bubble to achieve their goals under the
EU burden sharing agreement.
Allowance-based trading of kind (b) is a cap and trade scheme. Central
authorities designate an emission limit for the country, and each source has
an emission limit given to it in a national allocation plan. The permits are
freely tradable but each source must not, at some designated date, emit
more pollutants than it has permits for. The US acid rain programme is
the best example of such a scheme, but the EU Emissions Trading Scheme
(EU ETS) also has such features. Schemes of kind (c) and (a) are baseline
and credit schemes and tend to be project-based, that is trades are confined
to a single or small set of projects. A baseline level of emissions is speci-
fied and the difference between actual and baseline emissions is credited,
and credited amounts can be traded. The sources producing the emissions
do not (necessarily) have a total emissions cap as in the cap and trade
The scale of the existing carbon trade market is not easy to gauge (as of
2005). Lecocq and Capoor (2003) summarized the market (other than AIJ)
as comprising: (a) allowance trading currently about 4 per cent by volume
of total trades (excluding AIJ), but (b) about 70 per cent of transactions are
AAU. The main motives for trades are legal compliance, anticipatory legal
compliance with Kyoto, voluntary compliance, and ‘retail schemes’ (good
image projects). Between 1996 and 2003 project-based trades amounted to
220 mtCO2e with the annual volume doubling each year from 2001. Since
then most trades are Kyoto ‘pre-compliance’ projects, these trades having
been delayed during the period when the rules of trading were not clear.
The main players have been the World Bank’s Prototype Carbon Fund, the
Netherlands, and increasingly Japanese private buyers anticipating
difficulties with complying with Japan’s Kyoto target. Latin America has
been the largest host for projects in volume terms. Initial prices have been
lower than anticipated (the same phenomenon was witnessed with the US
sulphur trading market), but the market remains thin.
The major regional market is the EU ETS which started operations
in 2005 as part of the EU’s commitments under the Kyoto Protocol The EU ETS covers 12 000 installations and has two initial phases: 2005–07
as the start-up phase and 2008–12 as the first five-year phase, 2012 coin-
ciding with the end of the Kyoto commitment period (the time at which
targets must be met). The system is akin to a cap-and-trade with each
member State producing a National Allocation Plan (NAP) that has to be
agreed by the European Commission. There is no overall EU ‘cap’;
however, each Member State determines the total allowances in combina-
tion with the Commission. Permits are initially grandfathered (allocated
according to some formula related to past emissions or politically deter-
mined, but simply ‘given’ to emitters). There is however a facility for 5 per
cent of permits to be auctioned in the set-up period, and 10 per cent in the
first period. This is designed to make allowance for new entrants who might
otherwise be excluded by permit holders. To all intents and purposes the
currency of the EU ETS is the Kyoto AAU. Penalties for non-compliance,
that is for emissions that exceed allowances held at the end of an account-
ing period, are fairly severe at 50 euros per tonne CO2 in 2005–07 and 100
euros in 2008–12. It is anticipated that some 6 billion allowances will be
issued between 2005 and 2007 with an asset value of over 60 billion euros
(Hartridge, 2005). In early 2005, allowances were trading at around 10
euros per tonne CO2 (about 37 euros per tonne carbon).
Critics of emissions trading in the EU point to the complex way in which
the EU ETS links to national Member State policies. For example, instal-
lations covered by a domestic regulatory scheme can be exempted from
the EU scheme, provided this is agreed with the Commission. This may
limit the market. There is a linkage to the other Kyoto mechanisms, but
CDM trades can be integrated into the EU ETS only in a limited way. The
problem of ‘hot air’ remains. Hot air refers to allowances that are held by
some Eastern European countries, Russia and the Ukraine because their
Kyoto targets are actually below ‘business as usual’ emissions. They thus
have allowances that do not relate to any real emissions. If hot air is
traded, then buyers (for example EU countries) could count the allow-
ances against their own targets but there would be no corresponding real
emission reductions in the seller countries. Finally, there has been consid-
erable suspicion that the National Allocation Plans have been very gener-
ous and in alignment with ‘business as usual’ levels of emissions. Against
this, the Commission is known to have forced the revision of several NAPs
so that the national cap was lowered, and if allowances have been so gen-
erous it would be hard to explain the volume of daily trades (over 500 000
per day in 2005). Further, the 2005–07 phase is deliberately designed for
‘learning’, and experience with other trading schemes suggests that trades
will grow and prices will be firmer as the Kyoto commitment period
6. Conclusions
Overall, carbon finance demonstrates to the full the ability of markets to
respond to regulations with government intervention being minimized. It
is easy to criticize features of all the market creation developments in this
chapter – each could no doubt be better designed and more comprehensive
in coverage. But the significant fact is that these innovative solutions have
emerged in a remarkably short space of time. If we mark the beginning of
beneficiary-pays solutions with Coase’s essay of 1960, then those markets
developed within just 40 years. The carbon finance story is even more
remarkable. The notion of tradable permits was introduced by J.H. Dales
in 1968 (Dales, 1968), and within a decade forms of sulphur oxide trading
were being practised in the USA. Sustainable development clearly is a
major challenge, and some would say an unachievable one. But one thing
is sure – economists and finance experts have shown all the imagination and
resolve necessary to develop financial markets to respond to the challenge.
In the end it may not be enough, but there seem to be no limits to options
for financing sustainability.

Aucun commentaire: