The Real Meaning of Kyoto

We all know in one way or another that what the Kyoto Protocol does is limit emissions by establishing a finite amount of emissions credits that countries and companies can use. Limiting emissions will help the environment.

All of this is true, but it's not the main reason behind the Protocol's creation and how the Protocol will really help reduce emissions and help the environment. Before we can discuss the Protocol's usefulness and applications we need to take a step back and first begin with property rights and valuation. If you own an asset, chances are you can assign a value to it. The problem with the environment is that no one owns it and as such it has no clear value in monetary terms. When a coal company produces energy you're getting charged for its' costs, but what's missing from those costs is the damage done to the environment. This damage is extremely difficult to measure because, as I said before, there are no real good property rights on the air and water.

What the Kyoto Protocol does, and how it really works, is assign property rights of the air to countries and companies. Now that these property rights have been assigned we have some sort of measure as to how much damage is being done to the air. The idea is to eventually distribute fewer and fewer credits over time until pollution drops to negligible levels. Most of the basic ideas that worked their way into the Protocol can be found in this paper by Graciela Chichilnisky. Disclaimer: I took her class.

If you don't believe me that property rights feed into pollution, let's take another, more clear cut example of natural resources. The idea I'm going to lay down is that global poverty and pollution is linked to resource overextraction by developing countries and then pollution by developed countries. The reasoning goes like this: Why do developed countries import many natural resources from developing countries? Because they're cheaper. Why are they cheaper? Because of legal structure and property rights. Basically, if you extract a resource in a developed country and sell it, implicit in its price are depreciation and replacement costs because that resource is an asset that you own, and we have good property rights laws as well as accounting to make sure things are valued properly. Now let's take a look at a developing country with weak property rights laws and no depreciation/replacement cost accounting. In that country someone (might be a corporation, might be a sharecropping farmer) will extract a resource (wood, coal) from a piece of land that is loosely owned by the government or not really owned at all, take the rainforest for an example, and sell it at the market price. This price does not accurately reflect what the same good would cost in a developed country because of weak legal/property rights/accounting practices. Therefore developing countries overproduce resources, or sell them at a lower price, and developed countries buy these and pollute. This is not an optimal equilibrium by any standard.

A good corollary to this idea can be found in Coase's theorem, which states that as long as property rights are well defined, a situation can be bargained/argued through with a satisfactory result. But the catch is that the property rights must be well defined, which is what we don't have now in developing countries. So what we need is stronger legal structures and property rights systems in developing countries to bring up the price of resources to equilibrium and stop overextraction and pollution.

The irony is that all those crazy free market/no government intervention/libertarians/republicans are right. A true free market economy would really work. The problem is that the markets as we know them today are fatally flawed because they are not well defined enough to include all the costs and benefits, and therefore we have market failures in the forms of pollution and poverty. The answer? Kyoto a go-go.