Ganga Prasad G. Rao
http://myprofile.cos.com/gangar
These days, even the guy on the street is familiar with global warming, climate change, emissions taxes and emissions credits. After decades of wrangling, it is perhaps safe now to openly support (without triggering ‘RTI hits and FOIA misses’!) the claim that fossil fuel use has induced and accelerated climate change. Economists, ever so prescient, have proposed various schemes – from per capita emission limits to tradable, bankable emissions credits. Why, and notwithstanding the currency crisis, there is even a European Carbon Credit Trading market (that is when you trade Gouda cheese and thermal power emissions for Swiss cheese and home heating emissions!). But seriously, or more aptly, to tickle your cranial nerves, here’s one that you haven’t come across yet (unless someone smoked it outta me as I showered, and posted it before I trudged my last mile to the public computer center). So, what do I have to gain, and you to lose with a blog/column on the subject? Nothin’ much, no matter which side of the debate you stand on. And, what do I call this piece? Not my comatose day-dreaming and delirious rantings as I snake my way thru ‘Alice in Wonderland’ !
The Problem
In the beginning there were two Sultanates headed by, respectively, the ‘Blue IEA Sultan’ and the ‘Green GEF Sultan’ answerable only to the ‘World Bank Monarch’. The IEA Sultan sought the exploitation of all fossil fuel reserves and discoveries. The GEF Sultan wouldn’t hear of it until his adversary ‘diligently’ pronounced ‘Environmental Sustainability’. This impasse continued until the Big One, as the Monarch would imagine himself to be, asked them to hammer out a middle road between their polar positions. To cut the story short, and much as they hated each other, the two Sultans sat on opposite corners of the palatial hall and shouted across as to how much energy the global economy should consume and how much the earth could warm. With the world stock markets awaiting their word ever so impatiently, they decided to go with the advice of the Monarch’s scientific and economic advisors. The advisors put up charts indicating the causality and relationship between global economic output, energy intensity, carbon intensity of fuels, carbon emissions, CO2 concentration, and the Steady State Long-run global mean temperature, SS-LR-GMT, (the chosen measure for global warming) consistent with those emissions/CO2 concentration. To the relief of bond managers managing trillion dollar portfolios, the advisors also estimated the ‘Optimal Steady State Long run Global Mean Temperature’, T*, one that ostensibly maximized intergenerational global welfare while minimizing economic, environmental and social damages. The Sultans sagaciously accepted the advisors’ recommendations.
The Answer?
Required to dovetail their policies and realize the optimal SS-LR-GMT target, T*, or risk losing their Sultanate to the Monarch, the Sultans scratched their heads to come up with a solution to achieve it as early as possible without giving up either the natural resources at hand, or the profits churned up by the global economy. Wisely, they turned to their trusted Chair of Environmental Economics for answers. The academic, wizened by decades of wrangling for funds, the punches, barbs and stings from sponsors, stakeholders and critics in the academe and beyond for every paper he published in his illustrious career, chose to play a simple, yet effective ball game. He decided to pit the two Sultans in a head-to-head, multi-round boxing match!
All zealously profit-minded firms, were asked to line up behind the IEA Sultan. Those other firms that gave more than mere lip-service to ‘Corporate Social and Environmental Responsibility’ were suggested to accept patronage of the Green GEF Sultan. The Academic asked the two Sultans to administer the group of firms under them. The IEA Sultan was asked to maximize in each period, the aggregate accounting profits, Ht, of ‘n’ Blue firms under him:
The GEF Sultan was suggested he maximize a static ‘Net Resource Rent’ function, Dt,
where ‘OilRev’ stood for the total proceeds from Monopoly Oil sales to the IEA Sultan, ‘RF Outgo’, the cost of Carbon-Zero Renewable Fuel, CZRF, purchased from the IEA Sultan, P^ERt, the price of an emission right modified by the amount of change in SS-LR-GMT that it induced (the dollar price for a 1 degree temperature change in SS-LR-GMT), TProj, the current period projected SS-LR-GMT as determined by actual past period GMT, Tt-1, ERt, the emissions in the current period, and T*, the global welfare-maximizing GMT.
Now, the Blue IEA Sultan was eager to lead the Resource bandwagon, and anxious to fulfill all energy needs of the world. But, as ordained by the Divine Lord himself (The Monarch favored the Green Sultan who shared the Big One’s vision of the Earth being a Garden of Eden), the GEF Sultan cornered all rights to fossil energy production and supply. Entrusted with securing the Green Orb for the future, the GEF Sultan further sought and obtained the right to administer the Emission Rights (ER) Bank in which firms could deposit, hold and redeem their ERs.
Paradoxically, thankfully, and perhaps even appropriately, the IEA Sultan, now forced to buy Monopoly Oil from the GEF Sultan for firms under him, won both the right to control supply of ‘carbon-zero’ renewable fuels, CZRF, and the power to issue Emission Rights, ERs. Upstaged by the Green Sultan in resource rights, and green with jealousy, the IEA Sultan wrought his vengeance, first by monopolizing the production and supply of CZRF, and then, by allotting ERs free to Blue firms in amounts equal to the number of Oil barrels they purchased from him in auction each period. Blue firms could either apply the ERs toward oil consumption, bank them in an ER Bank, exchange them for CZRF barrels, or, trade them over to the Greens in ‘Blue’ ER Auctions.
His stature in the fossil energy market notwithstanding, the GEF Sultan was forced to buy CZRF from the IEA Sultan at monopoly prices and auction them to his Greens. Post the CZRF auction, the GEF Sultan also offered ‘gratis’ to Green firms those oil barrels not purchased by the IEA Sultan, on condition every barrel be consumed with an ER. Sharing their Sultan’s vision, the Greens bought ERs from the Blue firms in competitive, market-based, secret auctions. Green firms could apply the ERs to Oil consumption, exchange them for CZRF barrels, bank them in the ER Bank, and/or turn them in to their Sultan for ER credits, ERCs.
The Pay-Off
His brain sharpened by the decades of ‘walk the tightrope’, the academic tied the Sultans in to a further obligation. Fully cognizant of the conflict of interest, he specified a ‘Pay-off function’ for both Sultans - a function that determined their ‘take’ at the conclusion of each ‘boxing round’ which they themselves administered – a test of their morals and ethics. The IEA Sultan’s Pay-off function was, simply:
IEA Sultan Pay-off, POBt = ‘Blue’ Oil Auction Revenuest – Monopoly Oil Purchase Costt
The GEF Sultan’s Pay-off function was similar:
GEF Sultan Pay-off, POGt = ‘Green’ CZRF Auction Revenuest – Monopoly CZRF Costt + Aggregate Blue ER Auction Profitst
Rich Pickings? or Lean Meat!
At the conclusion of each round, the Monarch called upon the Sultans and satisfied himself that the economies were turning incrementally efficient and environmentally sustainable, even equitable. He further ensured the Sultans computed their Pay-offs only after reconciling Oil transactions in his office. In a strategy that revealed the Chair’s genius, revenues from monopoly oil sales to the IEA Sultan were distributed each round among Green firms in proportion to their ERC balance in the complement of the percentage ER profits that the Blue firms turned in to the ‘Blue ER Profit Bank’. The rest of the Monopoly Oil sale revenue (equal the % ER profit turned in by Blue firms in to the ER Profit Bank) went in to the Monarch’s Granary (Yes, the ‘Royal Resource Sink’ Bank!) until such time TPr exceed T*.
As further required by the Chair, the GEF Sultan, bound to his ‘Garden of Eden’ charter, turned in any excess from his Pay-off (POG-POB) over his counterpart’s, to an Environmental Remediation Fun, ERF. And in those periods, when the IEA Sultan’s pay-off exceeded the GEF Sultan’s, he turned the excess over to the Equal Opportunity Compensation Fund, EOC – a dole for firms at the bottom of the Blue Ladder meant to ensure their survival while yet new and small. The Green, recipients of residual oil barrels post the Blue auction, did not mind the EOC diversion.
After a re-computation of ER balances, and a re-jig of firms on the Blue and Green Ladder, respectively by cumulative profits and ERCs, the IEA Sultan, just as soon turned his attention to the next round, gauged the input and output prices, as well as the position of banked emission rights before deciding how much Oil to bid from the GEF Sultan. Not to be outdone, the GEF Sultan took stock of how much the past period GMT and emissions impacted upon TProj(‘Impact Function’), how that deduction impacted upon his Objective Function, and made anticipatory, compensatory adjustments to the amount (and implicitly, the price) of Oil he offered to the IEA Sultan next period. In that matter too, the GEF Sultan followed the advice of the Chair who guided him with a ‘Response Curve’ to quantify his decisions. The ‘Response Curve’ indicated how the GEF Sultan ought to alter the quantity of Oil offered to the IEA Sultan from period to period for various projections deviations from T*.
And as the bell rang for the next round, the Blue firms and the Green firms – the boxers – began to pull punches all over again. The Blue firms maximized profits while the Green firms were intent on generating income to purchase ERs and turn them in to ERCs, the measure by which Monopoly Oil revenues were distributed among them (and in fact, their ticket to ‘Nirvana’). Together, the Greens and the Blues, bid up or down the price of Oil, ERs and RF in a manner that signaled to the Sultans appropriate remedial policy measures to jointly maximize their take and yet conform to the Monarch’s objectives.
Signals and Incentives
The Monarch’s advisors examined the many stocks, flows and ratios in this ‘proxy boxing match’, but in particular, a) the number of banked ERs, and b) the ratio of the price of ER to the price of the marginal oil barrel. A positive change in the magnitude of banked ERs indicated an expectation of increasing economic activity, resource scarcity, and/or environmental sensitivity in future periods. Similarly, an increase in the ratio of the price of ER to the price of Oil suggested a lower pay-off for Oil exploration. The same were considered as macro-economic ‘signaling instruments’ to influence economic, environmental and resource policies.
Nirvana
At the Tea, a closing ceremony sponsored by the Monarch following a round, the two Sultans took stock of their ilk. The IEA Sheikh re-arranged Blue firms on the basis of cumulative accounting profit criterion; firms that had churned the largest cumulative profit holding the top rungs of the ladder. Rankings on the Green Ladder were decided by cumulative ERCs. Firms were then permitted to cross the road albeit on a case by case basis. Lured by the prospect of sharing the Oil auction rents, many firms sought to cross over the ‘Laxman Rekha’, and jump on to the Green Ladder. In other periods, some Green firms decided they had a better chance of climbing the ladder by churning out profits on the Blue side. Unmindful of the treachery, the two Sultans permitted firms to change sides, albeit on a case by case basis (the Blue Sultan wouldn’t as much give audience to the RF supplying firms). Moving firms could carry their ‘banked assets’ across the road but would need to conform to the rules and criterion on that side of the road.
As an incentive to compete and excel, the Monarch, in consultation with the Sultans, chose following each round a Blue firm and a Green firm at the head of the two ladders, for ‘Nirvana’, an exalted state signifying ‘principled success’. The Monarch bought out the Chosen Green of the round, while the corresponding Blue firm was rewarded with a ‘share buyback’ from the ‘Blue ER Profit Bank’ (In both cases, the shareholders had a little something to cherish). The Owners/promoters of the ‘Nirvana-Blue’ firm joined the Blue Sultan as ‘Slave Drivers’ (albeit ‘Administrators’) and took charge of managing the ‘Blue Line’, in particular the administration of the Oil auctions, the distribution of ‘EO Compensation’ monies to Blue tailgaters, as well as decision-making involving the various economic parameters necessary for the IEA Sultan to optimize aggregate profits. Owners/Promoters of the Green firm achieving Nirvana were privileged to serve as Environmental Judges on behalf the Monarch and entrusted with the administration of the Environmental Remediation Fund. To limit collusion, and self-audit the system, the Sultans occasionally winked at an exchange of administrators.
Death, ‘Punarjanma’, and the Birth of the Closed Cycle
To permit business failure concomitant with the graduation of ‘Nirvana firms’, and leverage it for the better of the Earth for a future economic cycle, the Monarch bought out one ‘failing’ firm each round from between the Greens and the Blues and re-structured it in to an entirely new Closed Cycle entity at the bottom of the ladder – alternating between Green and Blue ladders each round. The new entity was permitted to expand and move up the ladder only if it could conform to the guidelines of a closed-cycle economy.
Epilogue? Or a What If?
As it turned out, nations of the world were confronted with a horned-dilemma between choosing global economic depression and engendering irreversible global environmental damage. On the one hand, the Emissions Trading System, ETS, of the Developed world was distorted by the monetary greed of currency funds, hedging strategies of commodity funds, and geopolitical strong-arming of sovereign funds; on the other, developing nations, held back by per-capita policy-based subsidized economies, shied away from participating in the ETS, and turning it largely ineffective at controlling global GHG emissions. The proxy Moulin Slugfest between the Sultans’ Loyals was not an inappropriate strategy, perhaps even a middle road to an economic and environmental resolution between die-hard opponents and enemies.
This ‘Technology-Resource – Efficiency-Equity’ tussle between the Developing World and the Developed World continued while firms in ‘Moses Pariah’ nations played a Zero-Sum within their economies (as opposed to a ZS among firms across nations in the ETS) until they turned a lot more efficient, even a shade greener, and moved up in to the ‘Club of the Empowered’ (the G20). Both groups found the challenge of duopolic sparring rounds, the allurement of resource rents, and the dream of ‘Nirvana’ while achieving T*, ‘the grand utopia’, an economic-environmental alternative worth considering.
And as Moses herded his sheep across the River Jordan, the incentives to cross the Blue-Green divide diminished eventually, until it didn’t matter whether a firm or nation chose one or the other side of the road to the Garden of Eden!
ps: As for the Green and Blue Administrators, they had just enough coins, pennies and dimes left over to order an elaborately designed carpet for the boxing rink (and, matter of fact, did not mind a few loose ends!).
