Environmental Investments in Developing Countries - Climate Policy at Lower Cost

Germany and other industrialised countries can reduce the economic costs of climate protection considerably by means of emission-saving investment projects. Recent model simulations by the Centre for European Economic Research (ZEW), Mannheim, indicate that the emission reduction targets of the Kyoto Protocol can be achieved much cheaper by means of the so-called Clean Development Mechanism than by policy measures which Germany and other industrialised countries realise domestically. Also transaction costs and investment risks cannot affect the economic attractiveness of environmental investments in developing countries.

Industrialised nations do not compulsory have to achieve their future climate policy targets in their own country. The Kyoto Protocol facilitates investments in "clean" technologies (e.g. renewable energy) in developing countries in order to achieve the agreed reduction of greenhouse gases flexibly. The investing industrialised country receives emission reduction credits for the corresponding emission abatement. This is called Clean Development Mechanism (CDM) under the Kyoto Protocol. Particularly China, India and Brazil have attracted numerous of these environmentally friendly investment projects. CDM investments are often cheaper than domestic climate protection efforts because the state-of-the-art and the measures in climate protection already realised are more advanced in industrialised than in developing countries. Clearly, climate protection can be achieved there a lot easier with new environmental protection measures. By means of the CDM the industrial countries get regional flexibility in climate change policy and, at the same time, the developing nations receive environmentally friendly growth opportunities by means of investment, technology transfer and knowledge transfer.

A new ZEW-study simulated the corresponding economic impacts with a general equilibrium model of the world economy. The study indicates that CDM investments can reduce the cost of the Kyoto Protocol in 2010 drastically. The study reverts to a data base about ongoing and planned CDM investment projects which presents extensive, and at the same time cost-efficient, emission reductions in developing countries by the year 2010.

However, the strong use of the CDM in the future could be affected by investment barriers. The project activity causes so-called transaction costs which result, for example, from the contract implementation, legal advice or extensive project documentation. Such transaction costs particularly have a considerable impact within smaller projects. At the same time the projects in less developed countries often involve investment risks which occur, for instance, because of political instability or exchange rate fluctuation. However, the ZEW-study elucidates that transaction costs and investment risk indeed increase the permit price but do not have a significant impact on the macroeconomic costs of the Kyoto Protocol.

Contact

Niels Anger, E-Mail: anger@zew.de