Suppose that a country, Y, is threatened by a natural phenomenon, such as flooding. Y lacks the technological know-how to build sea walls, so it pays another country, Z, to build the sea walls for it. We would not normally criticize Z for charging Y to build the sea walls, even if Y is a poor country.
Now imagine that Y and Z share the coastline. The expected flooding imposes different costs on both countries: $90 million for Y, and $10 million for Z. And imagine that a single flood warning system would be the most efficient way to minimize these costs. A high-quality system would eliminate all of the losses but would cost $30 million. A low-quality system would halve the losses but cost only $2 million. Which system should be built?
Clearly, the high-quality system should be built, but it is equally clear that Z is not going to build it for free. Indeed, if left to its own devices, Z will build the low-quality system, at a net gain of $3 million, relative to doing nothing, and much better than building the high-quality system, which would produce a loss of $20 million.
So we would expect Y and Z to strike a deal. Z builds the high-quality system, and Y pays Z, say, $25 million. As a result, Y gains $65 million, and Z gains $5 million. A fairer division can also be imagined.
If all this sounds right so far, then the implications for greenhouse gas abatement policy are startling. Although scientific projections remain disputed, it is becoming increasingly clear that the costs of global warming will be unequally born by different countries. European countries will suffer a lot, as will India and many countries in Africa. China and the United States will suffer relatively little. And some countries, such as Russia, might even gain.
This means that the European countries (and India) are in the position of Y, and China and the United States are like Z. Of course, China and the United States are not planning to build sea walls that protect Europe, but greenhouse gas abatement on their part for the benefit of Europe is analytically the same as funding the high-quality system.
To reduce the level of greenhouse gases to that which is optimal for Europe, China and the United States would have to pay a lot, and yet they would gain less. Thus, if the logic of the example above is correct, Europe (and other countries) will have to pay China (and the United States) to reduce their emissions to a level that is acceptable to Europe.
It is increasingly becoming clear that a side payment will have to be made to China. No one has suggested that a side payment also be made to the United States. But why not? For a discussion, click here.