E C O N O M I C R E P O R T O F T H E P R E S I D E N T

A landmark international agreement to address the risks of climate changewas the Framework Convention on Climate Change, signed at the 1992Earth Summit in Rio de Janeiro. Building on this treaty, 160 countriesagreed to the Kyoto Protocol in December 1997. The Kyoto Protocolestablished binding greenhouse gas emissions targets for 38 industrializedcountries for the period from 2008 to 2012. The United States agreed to atarget of 7 percent below 1990 emissions levels. To promote cost-effectiveattainment of these targets, the agreement also established four flexibilitymechanisms: emissions target bubbles, international emissions trading, JointImplementation (JI), and the Clean Development Mechanism (CDM). Thelast three of these, if designed and implemented efficiently, could provide thefoundation for a global emissions market. Since greenhouse gas emissionshave the same climatic consequences wherever they occur, the most efficientway to address the risks of climate change is to reduce emissions whereversuch reductions are cheapest.Flexibility Mechanisms in the Kyoto ProtocolEmissions target bubbles effectively allow a group of countries to aggregatetheir emissions targets into one megatarget and to reallocate emissions tonew targets within this group. For example, all the countries of the EuropeanUnion have Kyoto Protocol targets set at 8 percent below their actual 1990emissions (written herein as 1990 –8). Under the bubble, the EU targetbecomes 1990 –8, and individual countries within the group have targetsthat vary between 1990 –28 and 1990 +27. Thus, those EU countries thatexpect to find it easier than others to reduce emissions effectively take onbubble allocations below their Kyoto Protocol targets, whereas those thatmay find the targets more difficult to achieve get bubble allocations in excessof these targets. The bubble concept allows for countries to engage cooperativelyin one set of “political trades” before the commitment period.However, once all EU countries have ratified the Kyoto Protocol, theallocations established under the bubble become their new targets.International emissions trading may occur among all countries with bindingemissions targets. With these targets, each country is allowed to emit a specifiedlevel of emissions: its so-called emissions allowances. Trading occurs when onecountry agrees to sell some of its emissions allowances to another country. It canalso occur among firms and other private sector entities that hold emissionsallowances through domestic trading programs. For example, a U.S. firm thatmust hold allowances for the U.S. domestic trading program could trade with aCanadian firm that must hold allowances for a Canadian domestic tradingprogram. For countries that have opted for a traditional regulatory approach ora charge approach to controlling emissions, it may still be possible forinternational trading to occur between firms and governments.266 | Economic Report of the President