Tuesday, December 4, 2007

Post-Kyoto and beyond- Do we have a solution to the Global warming

As I write this friends, representatives from around the world are in conference at Bali, Indonesia tryin to hammer out the next in what could possibly be a series of accords on global warming.

In this piece I am going to do some loud thinking and tryin to figure out whats the best way to deal with the global warming issue. In my opinion, to understand the nature of the problem would be the first step; and the defining characteristic of the global warming issue is that its a collective action problem.

A collective action problem is one when stakeholders collectively stand to benefit from acting in a particular way; however individually each stands to lose acting in that way. The global warming issue is a Collective Action Problem. Collectively humanity stands to benefit by going easy on carbon emissions; individually since lowering carbon emissions translates in to going easy on resource allocation to " development", each state will try and not act in a way that is collectively beneficient. So, China and India are not acting enough to curb carbon emissions unless the " developed west" takes to that way in a robust way. And since no one State knows how the other is goin to react, it acts in a way that it the best perceived course for itself ( and that of course as we saw earlier, is not the " Socially beneficient" course to take).

Collective Action Problems are seen in other spheres too; most notably in Depositor behaviour when there is a buzz that a bank is goin to fail. Collectively the Depositors stand to gain if there is no run on the bank; individually they stand to lose if they do not withdraw; and since none knows how the other is goin to react, they take the best course for themselves. The result: massive runs that translate in to asset liability mismatches and the bank fails.

So what is the solution to Collective Action Problems ; insurance is a solution that comes readily to mind. And indeed that is the one employed by bank regulators to curb bank runs and influence depositor behaviour when buzz of a bank failing is doing rounds!

Can a similar ex ante insurance fund be one of the solutions for the global warming conundrum? The fund thus created could be utilised for states and communities that say are " significantly affected" owing to global warming ( much like distressed banks utilise the insurance Fund)

Admittedly this insurance fund idea is not without its own set of issues; for instance, what would be the basis of Premium? Would it be Flat rate for all the states or risk based? While a flat rate system appears attractive in that it is easy to calculate and collect, it is a bit problematic because what that means is that powerful states incur some costs for the global warming that developing states cause. The developing States are not likely to consent to a risk based premium pattern because most likely if we were to have a "Dunn And Bradsheet" rating of risk profiles of all the states, developing States would most likely have riskier profiles than the developed West translating in to more premium for each of them.

There is also that familiar "bete noire" of all insurance-exponents- the Moral Hazard problem. But more of that later!

Interested readers may comment on this. Lets see if we can come up with somthing.

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