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09-03: The CDM and Sectoral Crediting Mechanisms:

Costs, Rents, and National Commitment Incentives

Abstract

A Sectoral Crediting Mechanism (SCM) shows promise as a means to encourage the transition from the Clean Development Mechanism to more-efficient climate policies. But as an open ended program, an SCM would discourage financial commitment by developing countries. Hence, a second transition, from profitable SCM programs to financial commitments, needs to be negotiated before an SCM is adopted.

Understanding national commitment incentives requires understanding the cost-coverage and rent-capture opportunities under SCM programs. These depend on design features such as credit discounting and ambitious baselines, as well as on informational asymmetries that effect the process of bargaining over baselines.

A traditional analysis indicates that credit discounting and ambitious baselines provide atmospheric benefits. More realistic assumptions, common in the literature but not previously modeled, moderate these conclusions substantially, and principle-agent considerations moderate similar findings concerning rent recapture.

Because rent transfers cannot be eliminated, SCM programs will more than cover all abatement costs in the developing countries hosting such programs. This can encourage the adoption of effective broad-based climate policies by host countries. However, it will discourage broad financial commitments to climate policy.

If adequate in scope, an SCM will soon become implausibly expensive for developed countries. Because it is not a long-run solution and discourages financial commitment, a global agreement on where it is headed should be in place before an SCM is adopted.

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