Hans-Werner Sinn

Nationalökonomie & Finanzwissenschaft

Ifo Viewpoint

Ifo Viewpoint No. 85: The Green Paradox

Munich, 09 July 2007

The protesters have returned to their home countries, the injured are licking their wounds, the heads of state are back to business as usual, and Heiligendamm, the old spa on Germany’s Baltic coast, is resuming its dream of imperial beauty. And German Chancellor Angela Merkel achieved a substantial diplomatic success. With charm and unassuming clear-headedness, she wrought a compromise from the G8 countries that may help save the world from the most severe devastations caused by global warming. The world’s eight richest countries promised to “seriously consider” halving their CO2 emissions by 2050.

The wording may sound vague, but, given the positions the countries held at the outset, the outcome was an important achievement. The United States, in particular, shifted its stance significantly since its rejection of the Kyoto Protocol, even accepting that the United Nations will have to organize the future negotiations.

But while the compromise is more than could have been hoped for at the outset, several important countries did not partake of it. To be sure, China, India, Brazil, South Africa, and Mexico signed on; but many countries, including the Asian tigers and most European countries, did not, despite their large contributions to polluting the world’s atmosphere.

Moreover, the oil sheikhs and other producers of fossil fuels who ultimately control the amount of carbon released to the atmosphere were not part of the deal. If major consumer countries and most producer countries do not join the agreement to reduce CO2 emissions, it could be useless.

Many believe that aggregate CO2 emissions are the result of independent decisions in individual countries. Thus, if a group of countries decides to have lower emissions, worldwide emissions will decline by the sum of these countries’ reductions. Sure, it would be better if all countries curtailed emissions, but it is already a great help if at least some countries do so.

Unfortunately, this view is too good to be true, because one country’s emissions are not independent from those of another. If countries decide to cut their emissions, they will have to reduce their consumption of fossil fuels, in particular oil. This will reduce the world price of these fuels, inducing other countries to consume even more than they otherwise would. Countries that cut their emissions would, in effect, be subsidizing their competitors’ growth, not necessarily reducing the speed of global warming.

The sacrifices of the participating countries would alleviate the CO2 problem only if their restraint meant that some of the fossil resources they do not consume remain underground. They must succeed in inducing the oil sheikhs and other producers of fossil fuels to throttle their pumps. If the sheikhs are stubborn and continue to extract as much as they had planned to extract without the G8’s restraint, the price of fuels will fall sufficiently to induce so much extra consumption among the non-participating countries that the net effect on aggregate CO2 emissions will be nil.

Will the oil sheikhs reduce output of fossil fuels? At first glance, it seems natural to assume this, as most suppliers reduce production when the price falls. But the sheikhs are sitting on fixed stocks of oil. If they do not extract it today, they will have to do it in the future if they want to make a profit. At best, it seems that the time path of extractions can be tilted toward the future. This would not solve the CO2 problem in the long run, but at least it would postpone the catastrophe.

The oil sheikhs would likely be inclined to postpone extraction only if they could reasonably assume that the demand reductions of the signing countries and the comparative price reduction that this implies are stronger today than they will be in the future. This is not plausible. Indeed, the sheikhs will know that, in all likelihood, concerns about global warming will increase over time. They will therefore speed up rather than reduce production, in order to avoid selling their oil when anxiety about CO2 peaks and the artificial measures of the signing countries to reduce their consumption have dampened the oil price most. Thus, green policies will paradoxically accelerate rather than mitigate global warming.

Two lessons arise from these considerations. First, all polluters must sit at the negotiating table and be forced or induced to participate in reducing pollution. The commitments of single countries like Germany to reduce their emissions more than proportionately are useless. Germany has already contributed three-quarters of the aggregate EU-wide reductions of CO2 emission from 1990 to 2008-2012 to which the EU committed in the Kyoto Protocol. Such a policy simply subsidizes other polluters’ CO2 emissions but does not alleviate the problem of global warming.

Second, and more difficult, the oil sheikhs and other producers of fossil fuels must be talked into postponing their extraction plans or, better yet, not to extract some of their resources at all. The best policy against global warming is to keep the CO2 imbedded in fossil resources deep underground.

The good news from Heiligendamm is that the UN will now have to organize a common solution. The bad news is that this is unlikely to happen in the foreseeable future, and that the owners of natural resources will therefore make every attempt to extract their resources and thus pump the fossil carbon into the atmosphere before the UN finds a way out of this impasse.

Hans-Werner Sinn
Professor of Economics and Finance, University of Munich
President of the Ifo Institute

Revised version. Published as "Die Logik der Scheichs", Die Welt, no. 157, July 9, 2007, p. 6; additionally printed in Les Nouvelles (Madagascar), Les Echos (Mali), Standard Times (Sierra Leone), South China Morning Post (Hong Kong), The Financial Express (India), The Korea Herald (South Korea), Business World (Philippines), The Sunday Times (Sri Lanka), The Nation (Thailand), Die Presse (Austria), L’Echo (Belgium), Borsen (Denmark), Aripaev (Estonia), Vilaggazdasag (Hungary), The Times of Malta (Malta), Danas (Serbia), Journal of Turkish Weekly (Turkey), Stabroek News (Guyana), Jordan Property (Jordan), Al Raya (Katar), Al Eqtisadaiah (Saudi Arabia), Duowei Times (USA).