Economic models have demonstrated that economic growth is possible in scenarios with both high carbon emissions and ambitious emissions reduction to limit temperature increases. Common scenarios (such as reviewed in IPCC 2007) predict that stringent climate policies will reduce GDP in 2030 by no more than 3 per cent relative to business as usual scenarios, with many models suggesting an even smaller reduction. To put this number into perspective, 3 per cent was the average of global annual GDP growth over the last thirty years. High estimates for mitigation costs therefore imply that the global GDP projected for the year 2030 is reached one year later, in 2031.

The Stern Review (2006) has identified three sets of policy interventions that are necessary to shift the economy onto a low-carbon trajectory and facilitate continued economic development:

1. 1 Putting a price on carbon provides the economic incentive for individuals and corporations to participate in the transformation. By providing a signal to these players as to the value of various carbon-reducing options, the carbon price allows market players to make investment, production and consumption decisions in a way that minimises the impact on their economic well-being.

2. 2 Tailored technology support encourages the development of new carbon-reducing technologies and can enhance performance and cost characteristics of existing technologies where the prospect of a carbon price alone would not be enough to motivate spending on research, development and deployment, or would not create sufficient demand for new technologies.

3. […]

During the Kyoto negotiations in 1997, only developed countries agreed to emissions-reduction targets. This reflected the principle of common but differentiated responsibility (Article 3(1), UNFCCC 1997). At the time, developed countries accounted for the majority of greenhouse gas emissions. Since then, many developing countries have exhibited impressive economic performance and a few countries have become richer in terms of GDP per capita than developed countries. As the economic development has largely followed the model set by Europe and the USA, early investment has focused on infrastructure built on cement, steel and manufacturing industries, and powered largely by fossil fuels, resulting in significant emissions.

Figure 7.1 illustrates how this has shifted the balance of emissions over the period 1990–2007. Counties such as the USA and Canada continue to exhibit extraordinarily high per capita CO2 emissions (y-axis) and emissions grew in line with population by 20 per cent. Emissions by economies in transition fell, with the structural changes after the fall of the Berlin Wall and efficiency improvements in industry, and are now at the level of per capita emissions of Western European countries in 1990. Western Europe achieved a 7 per cent per capita emissions reduction since 1990. With strong economic growth, per capita CO2 emissions in both China and India increased by 128 per cent. In addition, the populations of Asian and African countries have been growing. In aggregate, developing countries constituted 51 per cent of global CO2 emissions in 2007 (32 per cent in 1990).

In the Copenhagen Accord at the UN climate negotiations in Copenhagen, 117 heads of state concluded that low-emissions development would be necessary in order to combat climate change. However, at the end of a two-year negotiation marathon, they could not agree on emissions targets. In the following months, eighty-three countries submitted proposals to the United Nations Framework Convention on Climate Change (UNFCCC) secretariat for nationally appropriate mitigation actions (NAMAs), thus supporting the Accord and gradually rebuilding momentum for international climate co-operation.

One major challenge for the negotiations in Copenhagen was the shift of emphasis from marginal emissions reductions to low-carbon development. This is illustrated by the discussions on support mechanisms for climate policy in developing countries.

The Kyoto Protocol defined an international off-setting approach, the clean development mechanism (CDM): large emitters in developed countries can finance individual projects to reduce greenhouse gas emissions in developing countries if this is cheaper than reducing their own emissions (UNFCCC 1997). In this way, the cost of achieving the Kyoto emissions targets for the period 2008–2012 are reduced, but so are incentives to pursue more-ambitious mitigation actions in developed countries. As projects are directly supported within this international mechanism, domestic policy makers in developing countries have only limited involvement.

The Copenhagen Accord of 2009 emphasises the role of low-emissions development strategies. It invites developing countries to submit descriptions of NAMAs they envisage using for the implementation of these strategies. The Accord outlines technology co-operation and finance mechanisms to provide international support for their implementation.

Governments can put a price on carbon either by imposing a tax on carbon emissions (following Pigou 1920) or by using cap-and-trade schemes (following Coase 1960). Both concepts are simple in theory and have been discussed for decades. Ellerman et al. (2010) review the history of emissions trading and refer to Crocker 1966 as the first explicit expression of an emissions market. CO2 tax schemes were set up in Sweden in 1991 and subsequently in Denmark, Finland, the Netherlands and Norway, while cap-and-trade schemes for SO2 and NOX were established in the USA during the same period.

Cap-and-trade schemes have four basic components. (i) Governments set a cap on the total volume of emissions of a pollutant and create the corresponding volume of allowances. (ii) These allowances are distributed for nothing or sold to companies and individuals. (iii) The allowances can then be freely traded. This creates, in principle, economic efficiency. Companies that would face high costs to reduce their emissions will buy allowances from companies with lower costs, thus reducing the total cost of emissions reduction. (iv) Emissions are monitored and reported and, at the end of the accounting period, companies have to surrender to government allowances proportional to the volume of their emissions and can bank remaining allowances to the following year.

Climate change is a big challenge for our generation and society. This has led many to believe that one big solution is required and that there can be one international agreement and preferably one big technology to solve it all. The negotiations in Copenhagen did not deliver the big solution, and I think that would have been an impossible task.

What is this challenge? Limiting global temperature increases to 2 °C and reducing the risks associated with climate change demand large-scale reductions of carbon emissions. The reductions can only be achieved if all sectors of the economy are integrated into climate policy – to increase efficiency, find substitutes for carbon-intensive products and services and access low-carbon energy sources. The objective is not only marginal reduction of carbon emissions but the low-carbon development of our societies.

Low-carbon development thus has moved to the centre of climate-change policies: it became the backbone of discussions leading up to Copenhagen, was mentioned in the Copenhagen Accord, and was the basis for the subsequent submissions of proposals for NAMAs by eighty-three countries to the UN secretariat of the Framework Convention on Climate Change. This raises the question: what can countries to do develop in a low-carbon way?

Portfolio of climate policy instruments

Many economic activities create significant carbon emissions, which make it difficult for governments to micromanage individual carbon policies across a wide variety of industrial, commercial, housing and transport activities.

The previous chapter argued that countries and regions might pursue climate policies at different levels of ambition. This would probably include different carbon prices for a transition period, perhaps up to 2020. Now we will assess the implications of different carbon prices in countries connected by international trade. There are important opportunities and difficulties to consider. The opportunities lie in the first-mover advantages afforded to countries that support the development of low-carbon products and technologies. Just as Denmark's wind technologies have been established in world markets, new market leaders will emerge for other products.

But there is also some concern, that regions with high carbon price levels could risk inducing industry to alter investment, production and closure-decisions about plants, and thus move carbon-intensive production towards countries with lower or no carbon prices. This would have three implications that might have to be addressed by the design of the policy instrument and complementary measures.

• Shifting of production in response to a more-stringent emissions cap and associated policy to a country without a stringent cap creates carbon leakage. The freed-up allowances in the first country will be used by other sectors that reduce their efforts in emissions reduction. Whenever some of the shifted production is not covered by a stringent national cap it will increase emissions in the new country and thus contribute to a global emissions increase.

• Companies may limit passing through carbon prices to product prices either to protect current market shares, and hence delay relocation, or in response to output-based allocation of allowances. This dampens carbon-price signals for carbon-intensive commodities and services, reducing the economic incentive to substitute towards lower-carbon alternatives.

• […]

Limiting growth in global average temperatures to 2 °C above historic levels can only be achieved if greenhouse gas emissions are drastically reduced across all major emitting countries. It requires joint action across developed and, as discussed in Chapter 7, developing countries.

The need for joint action frequently prompts the question whether countries can and should pursue climate policy prior to an international agreement, or beyond the level of ambition thus agreed. Section 5.1 explores how international co-operation can enhance the level of national ambition by creating a sense of responsibility for own emissions and building trust and a sense of joint effort. Thus, international co-operation can encourage and support first movers and serve as a commitment device to facilitate effective policy implementation.

International co-operation can provide early and tangible results by encouraging and supporting transparent monitoring and reporting (section 5.2). With better information, governments can implement policies and programmes more effectively. It also facilitates rapid international learning on policy success and failure on how to achieve low-carbon development.

Of particular interest is the global carbon market. Section 5.3 outlines the design options, including a description and evaluation of trading at government or installation levels and the design options for such trading. Linking national carbon markets is usually described and analysed from the perspective of static efficiency gains. However, with increasing focus on low-carbon development, the incentives this can create for innovation and diffusion of low-carbon technology and infrastructure need to be considered (section 5.4).