Robust Incentives and the Design of a Climate Change Governance Regime

Abstract

In building a governance regime to address climate change, should we prioritize the development of global institutions or national ones? This paper adds insight to the issue of how much international coordination on climate governance is optimal by focusing on two neglected characteristics of the problem: first, the crucial role of incentives for private sector investors in low-carbon energy technology and second, that investors typically risk-adjust expectations of policy-induced payoffs because of historical policy volatility. Examining a case study of an important low-carbon energy technology, wind power, this study finds: (1) policy volatility has been substantial, (2) policy changes were uncorrelated across jurisdictions, suggesting that (3) investors could have substantially reduced their exposure to the risk of policy volatility by operating globally. While it also has downsides, a poorly coordinated international policy regime has the advantage of reducing the risk associated with a global policy failure. Beyond this case study, the importance of this positive effect depends on: the probability of policy failures in each country, the correlations among them and the probability of a global policy failure.

Keywords: climate change policy, incentives, investment, wind power

JEL Classification: Q42, Q48, Q54, Q55, Q58