Since the conference on climate change in Kyoto, Japan, in December 1997, the world’s industrialized nations have been grappling with the realities of a costly treaty. Passionate expressions of concern about global warming have given way to tough political bargaining over who bears the pain. The stakes are high. The decisions made in the near future—including the decision by the United States to ratify or not—will determine which countries, which industries, and which firms (if any) will bite the bullet of costly reductions in carbon emissions.

Illustration by Taylor Jones for the Hoover Digest.

The Kyoto Protocol calls for 38 countries in the developed world to cut greenhouse gases to roughly 95 percent of 1990 levels by 2012. This cut will happen mostly by reducing the use of fossil fuels, which emit large quantities of carbon dioxide.

The Kyoto accord would require industrialized countries to significantly reduce their greenhouse gas output, while allowing developing countries to continue to expand their output of such pollutants.

Total emissions of carbon dioxide and other greenhouse gases are much larger than they were in 1990. Thus, the industrialized countries, and especially the United States, face a daunting and perhaps impossible challenge. The United States must reduce the emissions projected for the years 2008 to 2012 by some 40 percent to meet its goal of reducing 1990 level emissions by 7 percent.

Yet the developing world, which emits large quantities of greenhouse gases, faces no challenge at all. By the terms of Kyoto, developing countries can continue to expand their output of carbon. So, with major emitters cutting back and minor ones expanding, it is highly likely that total carbon emissions will be larger in the future, not smaller, despite Kyoto.

This situation suggests that more is going on as a result of Kyoto than a commitment to reducing carbon emissions. The Kyoto Protocol creates a new and enhanced stage on which nations, groups, and companies can pursue their special interests. The treaty opens up opportunities for favor seeking that were previously closed.

Groups alarmed about global warming can still support the treaty on the grounds that carbon emissions may decline eventually. But others, including companies and countries who want bigger markets, appear to be paying more attention to the strategic here-and-now possibilities offered by regulation under the Kyoto Protocol. There will be winners and losers in the post-Kyoto struggle, and expectations about who will win and lose are guiding much of today’s political jockeying.

The Post-Kyoto Future

It is clear that if the Kyoto Protocol is fully implemented, the relative prices of major energy commodities will change. Economic studies show that the demand for natural gas will rise, as will the demand for oil, to a lesser extent. The demand for coal, however, will plummet. Many nations that now have comparative advantages based on large coal reserves and related technologies and manufacturing will lose those advantages. Certain ozone-depleting chemicals will be banned, expanding markets for their substitutes.

To meet the targets of the Kyoto Protocol, the United States would need to reduce its greenhouse gas emissions for the years 2008 to 2012 by some 40 percent.

National governments will engage in trade with other governments, but the items to be traded will be such things as the still-undefined “marketable emission permits” and “offsetting” actions to reduce greenhouse gases. In addition, countries will make bilateral agreements to transfer clean technology and provide development assistance, possibly creating emission offsets for participating countries.

Marketable greenhouse gas emission permits are the centerpiece of the Kyoto Protocol, although the scope of the market and the trading process have not yet been defined. An emission permit is a right to consume carbon and emit carbon dioxide in the course of production or manufacturing. To carry out the protocol, governments are likely to define a fixed number of emission rights equal to their Kyoto goals and divide them up among present carbon emitters. Since the goal in most developed countries is less carbon than is now emitted, emitters will have to cut back their emissions or buy the rights to emit from someone else. Either action is equivalent to paying a tax on carbon emissions.

Under a permit system, firms or countries that face high costs in cutting back (or that want to increase their carbon output) would buy carbon emission rights from firms or countries that could cut back at lower cost. An international permit-trading market is especially attractive to countries with high costs, such as the United States. Some countries with firms that have done little to control emissions could reduce their carbon output through relatively simple, low-cost changes. These credits could be purchased by countries facing high costs.

Bootleggers and Baptists

To understand what is happening now in the implementation of the Kyoto Protocol, it is helpful to consider some economic theory. The economic theory of regulation asks us to consider the political arena as a marketplace where favors are bought and sold. Interest groups that have the most to gain or lose will bid the highest prices for favors. Politicians dedicated to preserving their jobs, and needing large amounts of campaign funds, auction off the favors. Under this theory, if carbon emissions are to be controlled, the politician will seek the group with the largest economic stake in the outcome (and therefore presumably the most generous with campaign funds) and favor that group. Competing groups will attempt to outbid the winner. Usually, the smaller the group, the more each member can gain by crafting regulatory rules. The larger the group, the less likely that each individual member will have a strong reward or heavy burden as a result of the rules. So small special-interest groups usually are the most actively involved in the negotiations.

However, this theory is incomplete. Being a small, well-organized special-interest group is not enough. My theory of bootleggers and Baptists, a subset of the economic theory of regulation, further helps explain environmental regulation like that imposed by the Kyoto Protocol. Although powerful interest groups still matter, this theory tells us that there must be at least two quite different interest groups working in the same direction—“bootleggers” and “Baptists.”

The terms stem from the southern United States, where in the past and even today Sunday closing laws prevent the legal sale of alcoholic beverages. This is advantageous to bootleggers, who sell alcoholic beverages illegally; they get the market to themselves on Sundays. Baptists and other religious groups support the same laws but for entirely different reasons. They are opposed to selling alcohol at all, but especially on Sunday. They take the moral high ground, while the bootleggers persuade politicians quietly or behind closed doors. Such a coalition makes it easier for politicians to favor both groups. In other words, the Baptists lower the costs of favor seeking for the bootleggers.

The post-Kyoto period promises to be rich with bootlegger-Baptist coalitions. The Baptists are the active environmental groups pushing for ratification and enforcement of the treaty and working to prevent backsliding. They are passionate and persuasive to the public as they argue that cutting back on carbon emissions is a moral necessity. They are creating a groundswell for action on the Kyoto Protocol. (Indeed, the protocol even enjoys a “Baptist” supporter that gets close to the name itself—the United Methodist Church.)

If global warming is an illusion, the treaty will be a waste of time and a misuse of our resources. If global warming turns out to be genuine, the treaty will hinder our ability to adapt to it.

To determine which groups are the bootleggers, we should search for special-interest groups that are positioned to gain from regulatory enforcement and stringency or that must fend off losses that spring from proposed rules. In this role we see national governments, industries, and firms.

The Emerging Bootlegger Coalition

National governments are strategically positioning themselves to benefit from the negotiations while operating under cover of the international environmental groups sounding the alarm about global warming. When we survey the participants, we find that some countries, such as the United Kingdom, are positioned to exploit carbon reductions they have made in the past by raising the cost to economies that still rely heavily on coal. Other countries, including developing countries, are allowed higher emissions. These countries see opportunities for payments from the developed countries for reducing carbon emissions or for offsetting actions such as planting trees. In addition, within countries, some industries are favored by the rules and, within industries, some firms will also be favored. Meanwhile, environmentalists are running interference and providing cover.

Some signs of an emerging bootlegger-and-Baptist coalition are beginning to emerge. For example, environmentalists provide the cover story on which media attention is focused, while companies, industries, or countries work quietly in the background to gain benefits.

The principle bootlegger groups fall into the following categories.

1. Alternative energy bootleggers. In January 1997, Enron Corporation, a major provider of low-carbon natural gas, announced the formation of the Enron Renewable Energy Corporation. The company indicated that it was “preparing to take advantage of the growing interest in environmentally sound alternatives of power in the $250 billion U.S. electricity market.“ The new division faces the difficult challenge of producing solar and other nontraditional energy products at costs that can compete with conventional energy sources. Not surprisingly, Tom White, Enron Renewable Energy CEO, endorsed President Clinton’s $6.3 billion plan to fight global warming. This plan includes $3.6 billion in tax credits to spur the production and purchase of renewable energy and related technologies. Kyoto-justified taxpayer subsidies will make life easier for firms like Enron.

Other producers who have long enjoyed federal subsidies now hope to justify those subsidies in the glow of global warming. Consider the successful efforts of the National Corn Growers Association to extend the 5.4 cents-per-gallon federal tax incentive provided to producers of corn-based ethanol. Originally enacted on the dubious basis of providing energy self-sufficiency, the large ethanol subsidies were on shaky ground in early 1998. In April, the Renewable Fuels Association joined forces with ethanol producers to celebrate Earth Day by calling attention to ethanol’s beneficial effects on global warming. And Secretary of Agriculture Dan Glickman indicated his strong support for extending the ethanol subsidy, noting that "renewable fuels provide an important opportunity . . . to lower greenhouse gas emissions." No one mentioned that ethanol production is so costly that it might require more energy than it produces or that half of the federal government’s $600 million annual ethanol subsidy goes to one ethanol producer, Archer-Daniels-Midland. Nor did anyone mention a literal bootlegger-Baptist connection: the taxpayer subsidy assists the production of beverage as well as industrial alcohol. All this concentrated effort came to a successful conclusion on May 6, 1998, when House Speaker Newt Gingrich salvaged the ethanol program, much to the dismay of Senator Bill Archer, who wanted to end the program because ethanol blends reduce demand for Texas-produced gasoline products. But global warming helped save the day for the corn producers.

2. Natural gas and oil bootleggers. While ethanol and other bootleggers were joining with environmental Baptists, a coalition of major oil producers and other firms was having trouble keeping members opposed to Kyoto. The Global Climate Coalition, consisting of major oil firms and thousands of other firms, attempted to speak with one voice in debunking Kyoto’s shaky scientific underpinnings and calling attention to the economic effects of the protocol. But in June 1998, Shell Oil announced it was leaving the coalition.

Claiming credit for Shell’s green “conversion,” Friends of the Earth spokesperson Anna Stanford said, “We’re delighted that our hard work has paid off, that Shell has bowed to public pressure and seen that the future lies in fighting climate change and investing in green energy.” However, what may not be obvious to the public is that tough implementation of Kyoto implies growing demand for natural gas and that Shell (by its own admission) was eager to “promot[e] the development of the gas industry.”

Shell’s departure from the Global Climate Coalition was made easier by British Petroleum’s earlier defection. John Browne, CEO of British Petroleum (BP), stated that industry must play a “positive and responsible part in identifying solutions” to the global warming problem–a statement that sounds both concerned and responsible, just the sort of thing that environmental activists praise. But BP also expects to see an increase in demand for oil, its chief product, because oil is a substitute for coal that produces fewer carbon emissions. BP also announced a significant investment increase in solar and alternative-energy technology development.

To be sure, many major industries, or at least major firms, still oppose Kyoto. Not everyone is teaming up with the Baptists. Coal producers and related unions are among the most vocal in their opposition.

3. Countries as bootleggers. Even before ratification, some governments were taking steps to capitalize on the opportunities stemming from Kyoto. One country even found it possible to gain additional wealth for actions it was going to take anyway.

In April 1998, Costa Rica announced a new version of its program to save 1.25 million acres of rain forest. Costa Rican president Jose Maria Figueres said that environmental bonds, called certified tradable offsets (CTOs), will be sold to industrial firms. Each CTO corresponds to one ton of carbon that will be absorbed by trees. Under this arrangement, each CTO is backed by a specific number of trees left standing, which absorb one ton of carbon annually. By paying Costa Rica to protect its rain forest, polluters elsewhere can release more carbon emissions. It will cost Costa Rica nothing since it is something that the government is doing anyway, but it was expected to produce $20 million in revenues in 1998. Companies will pay $20 per ton of carbon emissions that are offset by the bonds. Costa Rica hopes to generate $300 million this way over the next 20 years.

In its present form, the Kyoto Protocol is an extraordinarily costly treaty for the U.S. economy. The United States would do well to reject it.

At about the same time, Japan and Russia engaged in what is believed to be the world’s first greenhouse gas emissions swap. The alliance illustrates Kyoto-inspired “offsetting” actions. Japan will send technicians to approximately 20 Russian power plants and factories to help Russia cut carbon emissions. In return, Japan can obtain credits to offset its required cutbacks. This arrangement is facilitated by the fact that Russia has no difficulty in meeting its Kyoto goal, a zero increase in carbon emissions above the 1990 baseline. With the Russian economy in shambles, production has fallen well below 1990 levels. However, Japan, which promised to cut baseline emissions by 6 percent, faces a real challenge. Reducing emissions of carbon there requires costly changes in fuel use.

Political Jockeying

The potential cost of the Kyoto Protocol to the United States is far greater than for other industrialized countries, even if trading is allowed. A number of major European countries have already reduced their use of coal. Others, like France, depend largely on nuclear energy, which produces no carbon emissions but leaves the country facing the challenge of reducing auto emissions.

Jockeying for competitive advantage between Europe and the United States is already evident. The prospect of having the United States reduce its costs by buying overseas permits is more than some international politicians can bear. Many in Europe want to make certain that the United States feels the pain of implementing the Kyoto accord. For example, United Kingdom negotiators oppose an international market in carbon emission offsets generally and also oppose trades that allow two countries to increase their emissions.

In turn, the United States has also played the “increase the rivals’ cost game” by battling various European Union proposals to minimize the emission reduction costs of EU member states.

As the post-Kyoto bargaining continues, there are at least two major institutional problems to be settled. The first is the permit markets—how they will be defined and operated and the extent to which this budding market will be unfettered by international rules and regulations. The second problem is the enforcement of agreements within and among countries that ratify the Kyoto Protocol. In efforts to clamp down on all forms of environmental cheating, ministers from the Group of Seven and Russia met recently to line up cooperation against environmental crime. Perhaps an international environmental police force is in the making.

In any case, a world industrial policy is in the making. In the past, governments such as France and Japan, and to a lesser extent the United States, engaged in industrial planning within their countries. The idea was to select the industries and firms that potentially would be the engines of the economy and allow the others to phase out gradually. Such industrial policy aimed at improving a nation’s economic well-being. It was never effective over the long run, but it created opportunities for favor seeking that gave some industries advantages over others.

The Kyoto agreement is setting up a system of industrial policy as well, although its purpose is not economic growth. Officials who manage the system will identify winners and losers in the battle over which nations will bear the greater pain of cutting back on carbon emissions. In this international system, as the Baptists work hard to adopt the treaty, the bootleggers will be converting environmental policy to an industrial policy that favors them.

Kyoto: Going down the Wrong Road

Day after day, newspapers report the pleas and alarms of the “Baptists” urging world leaders to do something about global warming, but, by and large, the machinations of the "bootleggers" go unnoticed. Yet there is ample evidence that Kyoto is already being used as a crutch to help conventional special-interest groups secure political favors. There is also evidence that some nations and at least one community of nations are acting in strategic ways to enhance their positions relative to other nations.

In the final analysis, we should hope that fear of global warming will subside and that efforts to control the world’s energy economies will gradually dissipate because the worry that ignited it will subside. Yet, even if this happens, the regulatory concrete delivered by Kyoto will endure. History teaches us that once a major concern becomes transformed into institutional rules, interest groups that invested in those rules will work to maintain them.

In its present form, the Kyoto Protocol is an extraordinarily costly treaty for the U.S. economy, and the United States would do well to reject it. If global warming is an illusion, the treaty will be a waste of time and a misuse of our resources. If global warming turns out to be genuine, those economies that maintain market flexibility will be best equipped to adapt to it. Yet Kyoto’s bootleggers are doing everything they can to destroy that flexibility. Either way, we are heading down the wrong road.

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