Modellers have examined a wide array of ideal firstbest scenarios for regulation of greenhouse gases. In this ideal world, all countries limit emissions from all economic sectors; regulations are
implemented by intelligent, wellinformed forwardlooking agents; all abatement options, such as new energy technologies and forestry offsets, are available; trade in goods, services and emission credits is free and unfettered. In the real world governments are more likely to adopt secondbest
strategies. We focus on a secondbest outcome that has received barely any attention by economic modelers: regulatory credibility.
If regulatory rules are volatile and not believable then firms and other agents are unable to be so optimally forwardlooking, and their shortsightedness leads to lower and misdirected investments in innovation and new technologies. In comparison with other secondbest factors that analysts have examined more extensivelysuch as varying participation by developing countries, limits on emission trading, and regulations by sector rather than across the whole economycredibility is up to 6 times more important in raising economic costs higher than ideal firstbest policy strategies. Low credibility is commonplace when governments tackle international problems because international institutions such as treaties are usually weak. But governments can boost credibility with actions such
as precommitting regulations into domestic law before international negotiations are finally settled. We quantify the benefits of precommitment using the example of China and show that it would be rational for it (and other developing nations that have been reluctant to adopt emission limits) to advance national limits on emissions unilaterally, which would make international regulations more credible and thus encourage Chinese firms to invest with a clearer eye to the future.
- issn: Q5, Q58
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- Keywords: GHG - Greenhouse gases, Secondbest Regulation