Friday, December 14, 2007

the Global Warming Conundrum part II- is risk based system, the best system of Premium levy?

Hi people, the last time i was on, i spoke about the likely solutions to collective action problems like Global Warming. the idea that an insurance fund on the lines that the banking business has to curb a similarly collective action problem of bank runs was mooted. the last time the question that i posed was what is the system of levy that this insurance fund should follow. this post would try and see if the risk based system is the best suited for this insurance fund.

but first things first, the question still remains if we are to prepare risk profiles of all the states in the Global Economy, what would be the parameters on which these risk Profiles would be based? i have tried and hammered a few of those;

Carbon Foot Print Per Capita

Technological Ability

Consumer Preferences

Political Climate

(A couple of more could be added to those and interested readers may post those)

Once we have a set of parameters to have a database of risk profiles, asking States to contribute based on their risk Profile is the next step. So, if China has a risk Profile of 7 on a scale of 10, it would have to shell out more per tonne of Carbon than say Nauru that would have a risk Profile of say 2 ( by specifyin a floor, we could also exempt Nauru from paying any premium, For Example, only Countries having risk Profiles above 3 may be required to contribute)

the last time i mentioned the moral hazard issue that is almost always cited when an insurance fund idea is floated; the moral hazard problem shortly stated is a bit like this ; if Godva has an insured vehicle, she would have at least some incentive to drive rashly,( the risk of the vehicle getting damaged or posing third party risks is hedged) is it not? thus if States know that they can get away by paying a minimum flat levy in the fund, which would be utlised to bail out States and Communities in the red, they would have incentives to pollute more. the beauty of having a Risk Based system is that you do not encounter moral hazard issues to the extent they arise in " Flat rate" system coz States pay in proportion to the risk they pose in causing "the red"; this makes them take Ex Ante measures to curb Carbon Emissions.

But we need to have a " carrots and sticks" approach to this process. China should have incentives for Example to climb up a place or two on the risk profile. the next post we will try and figure out how that approach may be beneficially employed?

No comments: