Korea’s leading role in joining the kyoto protocol with the flexibility mechanisms as “side-payments”

Korea’s leading role in joining the kyoto protocol with the flexibility mechanisms as “side-payments”

Shim, Sangmin


Recently, the term “climate change” has been increasingly used to refer to a change in climatic patterns “attributed directly or indirectly to human activity that alters the composition of the global atmosphere.”1 Unlike most naturally occurring climate changes, the present one appears to be rapid2 and one cannot rule out the possibility of unexpected climate transitions. Because climate change is a global issue, it is essential that major greenhouse gas emitting nations engage in collective action globally to slow or reverse the rise in the atmospheric concentration of greenhouse gases.

Two substantial barriers, however, hamper the effective design and implementation of mitigation efforts. First, there is a danger that the “prisoners’ dilemma” situation will prevail, where coordination is unlikely because every country is better off by behaving strategically and refusing to cooperate.3 Second, because it is impossible to exclude non-cooperative countries from enjoying the benefits of climate as a public good, countries have an incentive to be “free-riders,” encouraging collective action, but then defecting to maximize their own benefits.4 efits;.

global climate policy that may impose excessive costs on them.6

To overcome these tensions, it is indispensable to add incentives to the terms on which non-cooperative, developing countries will join the collective action. The importance of incentives is more strongly felt given that, in general, international sanctions are ineffective in prodding nations into compliance with the global objectives.7 Often these incentives take the form of “side-payments,” by which reluctant developing countries are bribed into international collective action.8 As long as such side-payments are not made in a fashion that encourages “cooperative losers” to engage in moral hazard,9 the charm of the side-payments will likely depend on their magnitude. On the other hand, some developing nations’ hold-out strategy for larger side-payments may cause developed countries to drop out for fear that they would bear excessive costs, with the result that cooperation becomes only partial among a sub-coalition of countries.10

most of the last fifty years in the development stage.12 Seen from this perspective, it will be an interesting case study to explore under what terms Korea may join the global efforts against climate change, given its status in the world economy as a leading developing nation. The importance of such an inquiry grows stronger because developing countries may look upon Korea’s case as a template in deciding their positions on climate change.

In this context, the Kyoto Protocol to the United Nations Framework Convention on Climate Change (UNFCCC),13 although not yet in force,14 is the most appropriate regime in which Korea may have an interest in participating. While the UNFCCC is hortatory in nature and only provides for “the vaguest of commitments regarding stabilization and no commitment at all on reductions,”15 the Kyoto Protocol prescribes binding reduction targets for the countries listed in the Annex B, mostly taking each Annex B country’s 1990 greenhouse gas emission as a baseline.16 If Korea accepts such obligatory reductions, it will be compelling evidence that the country is committed to the global efforts to cope with climate change.

used in domestic environmental regulation 20 and provide opportunities for parties to meet reduction targets at minimum cost. In addition, in the form of transfers of technology and financial resources, the flexibility mechanisms could also offer side-payments for developing countries participating in the Kyoto Protocol.21 Then two questions may be raised in Korea’s situation. Will the flexibility mechanisms in the Kyoto Protocol act as enough incentive for Korea to join the treaty? If the flexibility mechanisms turn out to be insufficient sidepayments, what must be done to enhance their attractiveness so that Korea may be induced to join the Kyoto Protocol?

This paper is an attempt to answer these two questions by exploring the potential of the flexibility mechanisms as incentives for Korea’s participation in the Kyoto Protocol. As a preliminary discussion, Part II identifies the conditions in which the flexibility mechanisms will work best, by relying on the United States’ experience in the use of tradable pollution permits. Part III explores, in detail, the flexibility mechanisms and highlights their possibility to work as side-payments. Part IV discusses four shortcomings of the flexibility mechanisms: two that relate to inherent design problems – “hot air” and supplementarity – and two that relate to external situations – the changed U.S. position on the Kyoto Protocol and the expansion in sinks. Part V makes a careful assessment of Korea’s position on the flexibility mechanisms and the prospect for the country’s participation in the Kyoto Protocol, based on interviews with Korean policymakers in the environmental and industrial fields. Against this background, Part VI suggests some revisions to the flexibility mechanisms to increase their likelihood of success. Part VII maps out a strategy for Korea’s participation in the Kyoto Protocol, and Part VIII concludes that the reinvigorated flexibility mechanisms will act as sufficient side-payments for Korea as well as developing countries in joining the global effort against climate change.


that both of them allow emitters – countries or firms – to rely on the reduction efforts made outside their areas in fulfilling their reduction requirements. Therefore, a brief discussion of tradable permits may be appropriate to draw implications for the effective operation of the flexibility mechanisms. Such consideration is also necessary to comprehend the process by which the transfer of technology and financial resources may take place when developing countries become parties in the Kyoto Protocol and take advantage of the flexibility mechanisms.


As one of the economic incentive instruments in environmental regulation,23 tradable pollution permits operate by initially setting an overall level of pollution throughout all sources. Then each source is allotted permits for its portion of the total, and firms that keep their emission levels below their allocation may freely sell their surplus permits to other firms that find it difficult to meet their targets. After trading in permits has been completed, it can be assured that the initial target of pollution control is met while firms allocate the burden of pollution control among themselves cost effectively.24 The number of permits is then usually reduced over time in order to reduce total pollution.

cost equals the permit price, thereby guaranteeing the minimization of total abatement cost among sources.27 The command-and-control approach can achieve the same result only with detailed information on each source’s cost function, which has to be obtained at very high cost.28 Second, tradable permits encourage the adoption of innovative technology by giving sources incentives to actively search for and implement better ways to attain their reduction targets.


As the first nation in the world to introduce pollution permit mechanisms into environmental regulation, the United States has a list of success stories, though somewhat limited, in the operation of tradable pollution permits. Looking into the U.S. track record thus may be of assistance in developing a checklist for the design and operation of tradable pollution permits in the international context.

1. EPA’s Emission Trading Program

2. Leaded Gasoline Phase-Out

In a move to allow refineries more flexibility while phasing lead out of gasoline, EPA introduced the lead-trading program in which refineries could bank or trade the credits from the surplus reduction of lead in gasoline from 1982 through 1987.(35) After the end of the program it was widely considered a success. Cost reductions are estimated to have been U.S. $250 million per year.36

3. CFC Phase-Out

A tradable permits market was used to bring production and consumption of CFCs down to the level set by the Montreal Protocol. The trading volume was not significant, though. Through the middle of 1991 there were only thirty-four participants in the market trading eighty production allowances.37 However, relatively low transaction costs involved in trading suggested that the CFC phase-out program was cost-effective.38

4. SO^sub 2^ Emissions Trading

Under the amended Clean Air Act of 1990, electric utilities were required to reduce total sulphur dioxide emissions by ten million tons from 1980 levels, but some provisions were also made so that they could trade allowances for emissions.39 This SO^sub 2^ allowance-trading program proved successful, and some research estimated the cost savings to be up to U.S. $1 billion annually.40


While the track record in the United States of the use of tradable pollution permits has been fairly impressive, in the course of the operation the permit system has also exposed several weaknesses that are attributable to design problems. The implications for the improved design of tradable permits, drawn from the experiences of the United States, can be summarized as follows.

is necessary for the government to commit itself to clearing up the uncertainty of the permits and to back them up with stringent enforcement.

Second, too thin a market structure where there are only one or two buyers of pollution permits creates a monopsony or duopsony.42 This makes it difficult for the price of the permits to rise to a level attractive to suppliers, leading to fewer incentives for firms to pursue technological innovation. To deal with this problem, the government must attempt to enrich the permit market through a crackdown on cheating by sources so that a significant number of them will resort to permit trading.

Third, considering equity concerns while designing tradable pollution permits might hamper the effective functioning of the permits and even eliminate the hard-earned efficiency gains. For instance, the “twenty percent rule” under EPA’s Clean Air Act Emissions Trading Program provides that, whenever a pollution permit was traded, the amount of pollution that it represented would be cut by twenty percent.43 This rule, adopted for equity between sources, has the implication that untraded permits will retain their value, thereby making trading in emissions unattractive.”Efforts to improve equity in the pollution reduction schemes may as well be made separately from the tradable permits.

Finally, transaction costs involved in using tradable pollution permits – for example, those over finding partners, negotiating terms of trade, and implementing the deal – weaken the potential cost-effectiveness derived from trading the pollution permits.45 Careful designing of a trading infrastructure to limit such costs is also indispensable in this respect.


Nevertheless, for those States that have agreed to the reduction targets of greenhouse gases, the flexibility mechanisms in the Kyoto Protocol may provide them with opportunities to achieve the reduction targets at the least cost. In this respect, the essence of the flexibility mechanisms may be identical to that of the economic incentive instruments in domestic environmental regulation. Moreover, because countries will take into account the availability of cheap means to attain the targets when they contemplate whether to assume the duty of pollution control by joining the treaty, the flexibility mechanisms in the Kyoto Protocol will also act as incentives for the countries’ participation in the treaty. Thus, the discussion above on tradable pollution permits in the national field may apply mutatis mutandis to the flexibility mechanisms in the Kyoto Protocol.

More importantly, the flexibility mechanisms provide developing countries joining the Kyoto Protocol with opportunities for technological and financial transfers. In fact, these two advantages are side-payments to the developing countries in exchange for agreeing to the participation in the international treaty. The question is whether these advantages of the flexibility mechanisms will be attractive enough for developing countries to overcome concerns about the constraints on their economy resulting from the efforts to reduce greenhouse gas emissions. While there is potential for the flexibility mechanisms to act as profitable side-payments, this potential is only conditional and will materialize in a limited manner.


Article 6 of the Kyoto Protocol provides that Annex B countries may use “emission reduction units” (ERUs) resulting from greenhouse gas abatement or sequestration projects in any other Annex B country in meeting their emission reduction targets. To qualify as Joint Implementation, such projects must: (1) be approved by the parties involved; (2) provide a reduction in emissions that is additional to any that would otherwise occur; and (3) be in compliance with their obligations under Article 546 and Article 7.(47)

help meet the nation’s reduction targets. However, the acquisition of ERUs must be “supplemental to domestic actions for the purposes of meeting commitments.”49

The advantage of Joint Implementation is that it offers countries a costeffective opportunity for greenhouse gas emission reductions outside their territories50 and a convenient way of facilitating the transfer of efficient technology.51 The Conferences of the Parties (COPs) were expected to work out further details of Joint Implementation,52 and the COP-7 held in November 2001 finalized such details by adopting a series of decisions under the heading of “Guidelines for the Implementation of Article 6 of the Kyoto Protocol.”53 According to those decisions, if projects starting in 2000 meet all the requirements, they are eligible as Joint Implementation but the ERUs may not be counted until 2008.(54) To oversee the verification of ERUs, the Article 6 supervisory committee, made up of ten members from parties to the Kyoto Protocol, was established.55

From the viewpoint of developing countries, Joint Implementation clearly offers a way to obtain environment-friendly technologies, and this might be considered favorably when developing countries contemplate participating in the Kyoto Protocol. However, Joint Implementation is more onerous than the CDM because it is only allowed for countries with binding reduction targets, whereas the benefits from Joint Implementation projects are not much different from those obtained by CI)Ms. Compared to the CDM, Joint Implementation provides less incentive for non-participatory developing countries to join the Kyoto Protocol.


cleaner energy.57 With the support of the United States, this led to the adoption of Article 12 of the Kyoto Protocol. However, as its details were finalized among informal contact groups at the last minute of the Conference, the text was not available to many national delegates before the closing plenary session.58

Under Article 12, Annex B countries may invest in emission reduction projects in non-Annex B countries, which are mostly developing countries, and may apply “certified emissions reductions” (CERs) generated by the projects toward meeting “a part of’ their emission targets.59 By specifying that the reductions in greenhouse gas emissions from the CDM can be used only partly in meeting the reduction target, the provision retains the requirement that the use of CDMs must be “supplemental to domestic actions.”

For developing countries, CDMs are an attractive device because they provide host countries with opportunities for technological transfer and financial inflows.64 However, they do not encourage developing countries to launch more extensive emission reductions by their own initiative, because CDM-hosting countries are institutionally limited to non-Annex B parties, for which no reduction targets are set. At most, the CDM gives incentives to developing countries to become parties to the Kyoto Protocol, but little is offered to engage them as parties with binding reduction commitments.


The three short sentences in Article 17 of the Kyoto Protocol, which provides for emissions trading, are representative of the nations’ strenuous efforts to reach a consensus on this most fragile topic.65 Inflammatory confrontations between developed and developing countries concerning this arrangement could have blown apart the entire negotiation.66 The developing countries remained suspicious of market-based arrangements, and emissions trading did not contain any provisions for the transfer of environment-friendly technology from developed countries. In any event, a detailed text on emissions trading was replaced at the last minute of the Kyoto Conference by an ambiguous draft submitted by the United Kingdom to break the impasse.67

The concept of emissions trading is to allow countries that have succeeded in achieving greenhouse gas emission reductions below their target levels to sell their surplus reductions to those countries that are struggling to meet their reduction targets. By making emission reductions tradable – and thereby a sort of property right between countries – emissions trading has the dual effect of maintaining global greenhouse gas emissions at a certain level, and of spurring technological progress. Once businesses spot the economic value in greenhouse gas emission reductions, they will seek ways to reduce emissions as much as possible in anticipation of the prospect of obtaining economic gains from the sale of surplus reductions.

reduction targets in the Kyoto Protocol.68 Given that many cheap reduction opportunities are in developing countries, financial resources could flow from the developed to developing nations once developing countries accept reduction targets, make domestic reduction efforts, and actively sell the surplus reductions through emissions trading. However, the success of such emissions trading as side-payments for developing countries depends on several factors, such as technological capacity, stringency of reduction targets, and the price of tradable emissions.

Because the modalities, rules, and guidelines for emissions trading were finalized at the COP-7,(69) it is likely that emissions trading will be ready to begin once the Kyoto Protocol comes into force.

Here again, the supplementarity requirement still stands: the last sentence of Article 17 provides that any emissions trading must be “supplemental to domestic actions” for meeting the reduction targets.


are not likely to fully realize their economic rationale, and they will fail to attract many countries, especially developing ones, into the Kyoto Protocol due to their reduced attractiveness.

This Part analyzes four problems in the flexibility mechanisms. Two are inherent shortcomings in the flexibility mechanisms, while the remaining two are events related to the workings of the flexibility mechanisms that seriously alter their effectiveness.


1. “Hot Air” Problem

The “hot air” problem, which is mainly a concern with emissions trading schemes but is applicable to other flexibility mechanisms in terms of the project baseline, can be defined as the “degree to which a country’s assigned amount exceeds what its emissions would be in the absence of any abatement measures.”73 In this case, countries with “hot air” will be able to benefit from the sale of these “surplus” reductions without creating any real, meaningful emission reductions, frustrating the objectives of the Kyoto Protocol itself.

This problem was known to be a possibility in some of the Kyoto allocations. In particular, a few parties in the relatively early stages of economic transition, such as the former Soviet Union and eastern European countries, had experienced a sharp decrease in their greenhouse gas emission levels as a result of serious economic recession since 1990.74 These parties form a source of windfall tradable emissions that industrialized countries might buy before they are declared not to be complying with the reduction requirements.75 The “hot air” problem has also triggered a heated debate on the justifiability of emissions trading itself, tipping the balance toward the countries that challenge the economic rationale of emissions trading as simply “pollution rights.”76

trading.”77 That is, inaccurate allocation of national emission targets based on erroneous projections will cause a consequence unfavorable to the global climate under emissions trading. Because “hot air” would not be a result of any genuine emission reduction efforts by selling countries, transferring it to a country having difficulties in meeting its reduction targets domestically would make emissions higher than they would be if emissions trading were not available78 and render emissions trading “empty of environmental benefits.”79 Moreover, without any reduction in greenhouse emissions, a cost-effective device for implementing an emissions reduction target would make no sense and such poor allocations will only contribute to undermining the economic rationale for emissions trading.

A more serious problem about “hot air” is its political ramifications. An emissions trading scheme that allows the wealthiest nations to benefit from false emission reductions attributable to the flawed assignment will be seen by developing countries as fraudulent as well as in violation of the spirit of the Kyoto Protocol. As a result, the reputation of the international treaty as a genuine global reduction effort will be severely damaged.s Furthermore, if some Annex B countries could take profits from the sale of “hot air” reductions, it would be politically difficult to prevent new, mostly developing countries from joining with overly generous emission assignments that would expand the volume of “hot air,” and the incentive for meaningful collective action would be lacking.81

2. Supplementarity

that Annex B countries may use the CERs earned from certain project activities for compliance only with “part of” their reduction targets.82

The introduction of such supplementarity provisions by the European Union83 was indeed a result of the divergence of national views on the flexibility mechanisms. In many instances, the Kyoto Protocol represents a compromise between the principle that emissions should be reduced first and foremost in industrialized countries that already record very high per capita emissions and the principle that the reductions should be achieved most cheaply wherever possible.84 The latter principle led to the development of the flexibility mechanisms, whereas the former appears to be embodied in the supplementarity requirement.85

Supplementarity has its own rationale: that too active participation in the flexibility mechanisms will limit the range of domestic policies, thus hampering the long-term technological innovation and enhancement of energy efficiency.86 However, the so-called “cap on trade” is in outright conflict with the concept of the cost-effectiveness that these mechanisms intend to achieve in carrying out emission reduction activities. A restriction on the amount of emissions available for trading would limit abatement in low-cost countries and force high-cost countries to stick to their expensive domestic reductions, lessening overall cost-effectiveness by diverging marginal abatement costs among Annex B countries.87

Moreover, the participation of private firms, essential for making the flexibility mechanisms a success, could not be guaranteed if the private firms saw a possibility that what they earned from those projects would be subject to limitations, seriously weakening their economic value.


1. The United States’ Decision Not to Ratify the Kyoto Protocol

reason that President Bush referred to in justifying the United States’ decision was that the Kyoto Protocol did not ensure the participation of such developing countries as China and India, which could soon be ranked among the largest emitters of greenhouse gases.gg The other reason, which appeared to have more significantly influenced the President’s decision-making, was the possibility that ratifying the Kyoto Protocol would seriously hurt the American economy.89

The changed position of the United States, although astounding, had been anticipated since the failed negotiations in The Hague at the COP-6. Considering that the United States had to reduce the emissions of greenhouse gases seven percent below its 1990 emission level in the first commitment period, it either should have started early on more stringent domestic efforts to limit greenhouse gas emissions, or should have hammered out a consensus on the details of the emissions trading at the negotiation table. Because the United States failed on these two fronts, due to both the lack of political will to implement climate policy domestically and the strong opposition from the European Union in the negotiations over loosening the requirements of the trading mechanisms, its choice appeared to be inevitable – to drop out from the Kyoto regime.90

Whatever the reasons for the United States’ withdrawal, the country’s decision is expected to have an adverse impact on the economic rationale of the flexibility mechanisms through a shift in demand for tradable emissions. Now that the reduction target specified in the Kyoto Protocol does not bind the United States, it is no longer likely that the United States government and firms will actively participate in the tradable emissions market to purchase emission permits. The absence of the United States as a buyer in the tradable emissions market will translate into shrunken demand for tradable emissions, which will lead to a lower price in tradable emissions.91 This low price in emissions will also discourage prospective firms in the Annex B countries to spend much in research and development for emission-reducing technologies, effectively eliminating the possibility that the supply in tradable emissions may increase in the near future.

credit system for companies that voluntarily cut down on greenhouse gas emissions, and a fund amounting to U.S. $4.6 billion for research and development in clean energy technology.93 By this announcement on climate policy options, the United States made it clear that it would attempt to reduce emissions of greenhouse gases unilaterally, at least for the next ten years. Such articulation of the United States’ standing has also dashed any hope that the nation might soon return to the Kyoto Protocol, which will set the negative tone on the effective working of the flexibility mechanisms for the foreseeable future.

2. Expansion in Sinks94

In addition to active efforts to reduce greenhouse gas emissions, the Kyoto Protocol contemplates the use of sinks as another way for Annex B countries to achieve their national targets for emission reductions.95 Since the COPs were entrusted with the task of deciding on modalities, rules, and guidelines for reporting and verifying the use of sinks,96 State parties attempted to reach an agreement on the guidelines in every COP, without any significant breakthroughs until the last two COPs. The main reason for the delay was that there was too much uncertainty involved in measuring the amount of removals of greenhouse gas emissions by sinks.97

The United States’ decision not to ratify the Kyoto Protocol early in 2001, however, drastically changed the State parties’ resolve to finalize details of the sinks. Perhaps as a backlash against the United States’ unilateralism,98 at the COP-6 bis and at the COP-7, major negotiating parties such as the European Union, Japan, Canada, and Russia quickly put aside their differences and agreed on the guidelines covering modalities of the sinks and their verification.

position on sinks at the COP-6(99) and a concession to the countries whose ratification of the Kyoto Protocol was deemed necessary to assure its coming into force even without the United States’ participation. Japan, for example, was assigned a maximum credit of thirteen million tons of carbon per year (Mt C/yr), which could be acquired through forest management. Likewise, Canada could benefit from sinks for up to 12 Mt C/yr, and Germany for up to 1.24 Mt C/yr.100 Most remarkable was Russia, which had already obtained a maximum credit of 17.63 Mt C/yr at the COP-6 bis,101 and had its maximum credits increased further to 33 Mt C/yr at the COP-7.(102)

These developments are likely to affect the flexibility mechanisms through shifts in supply and demand for the tradable emissions. First, because countries such as Russia now have additional means of reducing greenhouse gas emissions and the allowed volume for emission reductions is significantly large, they may achieve additional surplus reductions by combining active use of the technology to reduce greenhouse gas emissions and the conservation and increase of sinks through forest management activities. This may in turn lead to an oversupply of tradable emissions, which is likely to decrease their market value.103 Under these circumstances, firms would find little incentive to participate in the carbon emissions market, and the development of the market is not likely in the near future.

Such a contraction in demand would in turn make the market for carbon credits highly unprofitable by raising the transaction costs of finding partners and thereby lessening incentives for firms to participate in the market for carbon credits.

One possible way to alleviate the impact of sinks on the price of tradable emissions would be the “banking” provided by the Kyoto Protocol.104 Even though a recent decision on modalities for the accounting of emission units states that the “removal units” (RMUs) acquired from the use of sinks cannot be carried over into the subsequent commitment period,105 they may easily be changed into other bankable credits such as ERUs and CERs that do not have serious restrictions on carry-over.106 Saving surplus reductions from sinks for future use could ease a downward pressure on the price of tradable emissions in general. However, because it is wholly up to the governments to decide whether or not to put all of the surplus emission reductions on the market, there is no way to ensure whether and how much banking will occur. On the contrary, countries such as those from the former Soviet Union bloc are more likely to sell all the reduction units, even at a low market price, because they have acquired these opportunities for reductions as a windfall. Because such countries are currently in need of financial resources, however small, to revive their economies, they are even more likely to sell their units sooner. From this perspective, banking the credits from the use of sinks will not be a practical option for countries, at least in the first commitment period.

In sum, the United States’ decision not to join the Kyoto Protocol rallied other countries together in hammering out the details of the international emissions trading mechanisms and preparing the Kyoto Protocol to come into force, but due to the urgency to revive the moribund treaty, the negotiations over sinks conformed to the demands of the key nations. This had an adverse impact on the effective functioning of the flexibility mechanisms by expanding supplies of the tradable emissions and by decreasing their demand among the countries participating in the mechanisms.


their economic potential due to their structural shortcomings and the expansive use of sinks. Such drawbacks will also dim the prospect that the flexibility mechanisms will become attractive side-payments for developing countries. The expected low level of financial income resulting from the low price of tradable emissions will be too small to persuade such countries to turn their priority from development to global climate change.

The remaining question is whether these predictions based on the theoretical analysis will become reality. As suggested in the introduction, Korea was selected as a case study for the relationship between the flexibility mechanisms’ potential and the country’s prospect for participation in the Kyoto Protocol. To analyze Korea’s case with more precision, five in-depth interviews were conducted with policy-makers engaging in national climate change strategy and/or in international negotiation over Korea’s participation in the Kyoto Protocol. Interviewees include: a member of the Korean National Assembly; two governmental officials – one in the rank of deputy director in the Ministry of Foreign Affairs and Trade (MOFAT) and the other in the Ministry of Commerce, Industry and Energy (MOCIE); a staff-person from the Korean Chamber of Commerce and Industry; and an activist from the Korean Federation of Environmental Movement (KFEM), a leading NGO. These interviewees were chosen based on the “political market” framework in environmental regulation, according to which various interest groups, such as industrialists and environmentalists, compete with each other to influence legislators in the choice of certain policy instruments they support, using support for the legislators’ re-election as their leverage.107

These interviews108 revealed that Korea’s stance on the participation in the Kyoto Protocol has little relationship to the potential of the flexibility mechanisms, possibly as a consequence of Korea’s free-riding/risk-averse strategy combined with the ineffectiveness of the flexibility mechanisms.


dependent on fossil fuels, Korea’s emissions are likely to continue to increase. A report from the International Energy Agency at the COP-7 estimated that Korea’s carbon dioxide emissions, standing at 410 million tons in 1999, would increase to 600 million tons in 2012, becoming the world’s seventh largest carbon dioxide– emitting nation.111


While Korea is a party to the UNFCCC,112 it has signed, but not ratified, the Kyoto Protocol and therefore remains a non-party.113 The interviewees in the government and the National Assembly agreed that Korea would probably ratify the Kyoto Protocol, because other industrial nations would demand Korea’s participation based on the fact that Korea is currently the world’s eleventh largest greenhouse gas emitter.114

ratify the Kyoto Protocol before September 2002 and commit itself to binding reduction targets for the second commitment period of 2013 through 2017.(119) However, he admitted that decision-makers would not listen to NGOs seriously, and that the appropriate role of NGOs in environmental movements is joining the government in public awareness initiatives.120 The attitude of Korean decisionmakers, perhaps conscious of the low political risk and great comparative advantage over nations that are reducing greenhouse gas emissions, may be termed “rational” on the basis of choosing the best available means to the ends based on all available information.121 This attitude, however, could be criticized as opportunistic, or in economic terms, “free-riding” on other countries’ efforts to mitigate climate change.122

and Industry early in 2001, before the details of the flexibility mechanisms became final, showed many firms’ reluctance to take actions under circumstances of great uncertainty.127

These remarks demonstrate that the policymakers’ caution about the flexibility mechanisms’ potential is “risk-averse”128 behavior in the sense that Korea would rather accept less benefit with certainty than more benefit with risks. In this case, staying outside the Kyoto Protocol would cause the loss of business opportunities and the prospect of incoming financial resources. As discussed in Part II, too much uncertainty about the flexibility mechanisms reduces the incentives for firms to join in the arrangements and keeps policymakers away from the consideration of the flexibility mechanisms’ economic potential. This corroborates the hypothesis that the flexibility mechanisms, weakened as they are by recent developments, will not greatly influence Korea’s participation in the Kyoto Protocol.


proposal on the Unilateral CDM,132 the Korean government intends to keep pressing for the parties to approve the mechanism.

Korea’s suggestion for the redesign of the CDM to accommodate projects implemented between developing countries or in the developing country itself may be seen as another attempt to attract participation from the developing countries that possess the technology to reduce greenhouse gas emissions and to accelerate industrial development. The proposal may also have potential to make the carbon credit market more viable by opening wider business opportunities for carbon credits to firms in developing countries, including within their own territories. The developing countries may earn a decent return on their investment by selling carbon credits to other countries that are in need of additional emission reduction credits.

However, because the Unilateral CDM would be in place as a competing arrangement with CDMs, the proposal has already drawn opposition from developing countries such as China and India,133 which are widely expected to be beneficiaries from CDM projects. Moreover, when the emission reductions realized through the Unilateral CDM become available to the market, countries that have been considering investment in CDMs may instead purchase carbon credits from entities participating in Unilateral CDMs. Most importantly, the concept that countries not required to reduce greenhouse gas emissions are allowed to benefit from the sales of carbon credits to countries under heavy obligations may be simply unacceptable from an equity standpoint. These factors may well explain why the Unilateral CDM has received little global support and why it is unlikely that Korea will successfully promote it in the future.


devices exist in the Kyoto Protocol to entice other countries’ participation, also raises a serious question about whether the Kyoto Protocol will be able to achieve extensive reductions in greenhouse gas emissions. Without the participation of major developing countries – which are expected to surpass developed countries in terms of greenhouse gas emissions134 – there will be virtually no way to stabilize greenhouse gas concentration at a level that is acceptable for global ecosystems, because there is a limit in the potential for emission reductions from developed countries alone.

Such considerations necessitate discussion on how to change the flexibility mechanisms to accommodate developing countries’ concerns for economic development. In addition, measures to fix the mechanisms’ drawbacks to ensure they generate more genuine and flexible emission reductions are worth contemplating. The following suggestions are not intended to solve all problems, but they could contribute to an environment in which the flexibility mechanisms have the chance to reach their full potential.


The Kyoto Protocol essentially takes a “deep, then broad” approach in which developed countries take the lead in assuming obligations to reduce emissions of greenhouse gases and developing countries are expected to follow suit.135 However, given that the international community has limited means to force countries to accept certain obligations and prevent the free-rider problem,136 most of the meaningful actions by States are done on a voluntary basis. Therefore, there is no guarantee that developed countries’ initiatives will be matched by subsequent, comparable commitments by developing countries.

permits is restricted, which would contradict the concept of the hybrid approach itself.

The other approach, which involves an international carbon tax, contemplates coordination among nations on a tax that firms will pay to their governments in accordance with their greenhouse gas emissions.141 If this scheme is implemented, firms will attempt to limit emissions of greenhouse gases to the level at which the marginal abatement cost for one unit of greenhouse gas emission equals the tax rate. Then firms would be freed from concerns of high abatement costs and make efforts to reduce greenhouse gas emissions as much as their cost functions allow.142 The tax payments would form an additional source of revenue for governments, which they could either use according to their policy imperatives or to lower other taxes.143 The prospect of tapping a new source of revenues could even induce developing countries to join international efforts against climate change.

However, the idea of introducing a new tax would be politically difficult to push through in developed nations,144 partly because their taxpayers already resent current tax levels, which they perceive as being too burdensome. On the other hand, except for multinational corporations, the revenues gathered from the implementation of an international carbon tax would come from the pockets of nationals in each State, a concept which governments of developing countries might find unacceptable because it does not address equity concerns or the historical responsibilities of developed countries. Therefore, developing countries would not agree to an international tax regime unless it entailed a transfer of significant financial resources from developed countries, an option that developed countries would strongly argue against. In sum, it is implausible that countries would easily agree to a level of carbon tax and the institutional mechanisms to bring them into effect. An additional shortcoming of this approach is that it would be impossible to know how much greenhouse gas emission reduction could be achieved by a tax system, even though the abatement costs might be stabilized at a certain level.145

that allows developing countries “room to grow” but makes those countries identifiably committed to global reduction efforts. In this context, recent discussion on ways to broaden participation in the Kyoto Protocol draws attention to the new concept of target-setting, which basically links reduction targets to a country’s national growth rate.146 For example, if a country’s national economy is expected to grow five percent annually on average for a given time, the country’s emission reduction target may be set to accommodate this growth, thus allowing that country to emit five percent more greenhouse gases annually for the target period. This “dynamic target” could be subject to ex post adjustments, to take into account the unexpected changes.147

This new method for setting targets under a generous base has several advantages. First, combined with the emissions trading scheme, a country’s effort to reduce greenhouse gas emissions by even a small amount as compared to its business-as-usual (BAU) emissions will produce tradable emission reductions, 148 which could be a source of income. This will encourage developing countries to more willingly join the Kyoto Protocol and accept the binding reduction targets in anticipation of the inflow of financial resources. Second, because the reduction in emissions of greenhouse gases would be genuine, developing countries could not be criticized for taking advantage of “hot air,” which would more strongly justify the rationale of the new approach.

From a political perspective, this method could gather support from both developing and developed countries. Developing countries that feel secure about their economic growth would be willing to make use of larger business opportunities. Similarly, leading developed countries would likely acquiesce to this new approach because the possible expansion of opportunities for cheap emission reductions would help them lower abatement costs.

countries that might become large emitters in the future – even at the expense of more emissions than ideal – would be worth trying. In addition, considering that uncertainty about abatement costs remains, the fixed target approach under the current Kyoto Protocol regime would not be preferable to more flexible architectures,150 which the dynamic target approach duly embodies.

This approach has one major difficulty, however. Allowing more developing countries to join the Kyoto Protocol with generous dynamic targets would increase the supply of tradable emissions. That would naturally cause the price of tradable emissions to decline, which might discourage private firms from investing in emission reduction technology.151 Moreover, lower-priced emission permits might translate into less incentive for developing countries to participate in the Kyoto Protocol, seriously dampening the rationale of the dynamic targets.

This may be the price of adopting a dynamic target approach. Nevertheless, because developing countries’ major concern – undeterred economic growth — could be assured by the dynamic target, these countries might think of tradable emissions as a bonus and thus might not be significantly sensitive to the fluctuation of carbon price. If developing countries were indeed concerned about the price of tradable emissions, they could also take advantage of the “banking” provision in the Kyoto Protocol, saving unused emission permits until the permit price has risen high enough to guarantee sizeable income.


Addressing the “hot air” problem is difficult in practice, because strong opposition from nations that may gain from “hot air” trading is likely to scuttle any efforts to restrict such trading. More realistically, limitation of “hot air” trading should be discussed only after the end of the first commitment period when the problem could be dealt with by assigning emission reduction targets more carefully to meet ecological needs.153 Another conceivable approach would be requiring nations to bank a significant amount of “hot air” into the next commitment period, which could ease the decline on the permit prices in the first commitment period.154

In the long term, however, setting a firm principle against “hot air” trading rather than seeking an expedient solution will be indispensable for the trading mechanisms to function soundly. Even if reaching a conclusive agreement on “hot air” trading is hard to achieve, it is a goal worth pursuing. Furthermore, the dynamic target approach, if accepted, could moderate nations’ opportunistic behavior to preserve “hot air” in the trading mechanisms and more attention would be given to the genuine emission reduction opportunities. Because “hot air” does not represent real greenhouse gas emission reduction, preventing countries from engaging in “hot air” trading would be desirable. However, without clear principles to identify “hot air” and ban its trade, any attempts to redress this problem may end up intensifying uncertainty and decreasing the attractiveness of emissions trading to countries and firms, as suggested in Part II.

As it is likely impractical, if not impossible, to differentiate beforehand “hot air” trading from authentic emissions trading, the ex post verification of the genuine tradable emissions at the end of the commitment period may be a feasible solution.155 In the meantime, emissions trading itself must not be restricted so that the market for tradable emissions is kept stable.

be assigned more onerous reduction targets in the next commitment period.156 On the other hand, if sellers bear the consequences of “hot air” trading, a set of penalties such as a ban on selling countries’ participation in emissions trading for the next commitment period would be applied,157 while the traded “hot air” would retain its value as surplus emission reduction.

The above situation concerns the question of who should bear the risk of “hot air” trading. If buyers had to bear the risk through subtraction, it would make purchasing countries wary of the genuineness of emission reductions before trading, and each reduction would have different values and risks.158 This would make purchasing countries conscious of the possibility of subtraction, leading to less participation in emissions trading and a decrease in the price of the tradable emissions. On the other hand, if sellers were to bear the risk of “hot air” trading, tradable emissions might become less available and their price would increase, making purchase of surplus emissions reductions unattractive and weakening the market structure. Each proposition thus has its own shortcomings.

A consideration of which side will be in a better position to insure or self-insure against the risk of “hot air” trading helps resolve this dilemma.159 Presumably purchasing countries are mostly those that are rich and developed, which may find it costly to reduce greenhouse gas emissions domestically because of their already advanced industrial structures. Given their capacity to gather and analyze information and their financial resources, they are expected to be better than the developing, selling countries in avoiding the purchase of “hot air,” and/or bearing the consequences when, despite their efforts, their purchase of tradable emissions are later determined to be “hot air.” From an economic point of view, therefore, rules that make buyers bear the risk of “hot air” trading will be more efficient and should be adopted.


incentive instrument may fail to achieve cost-effectiveness when other considerations, such as equity, are inserted directly into the mechanisms. In addition, putting a cap on the maximum amount of emissions that one country could purchase would act as a restriction on the demand of tradable emissions, in turn driving down the price. In the case of an excessive supply of permits, the lowered price would discourage firms’ research and development in new technology, causing fewer reductions than would have occurred without restrictions on trading.160 This would also adversely affect the long-term goal of bringing developing countries into the Kyoto Protocol, because they would be uncertain about the prospects for profitable emissions trading and might determine that the incentives offered were not sufficient to warrant their participation.

Therefore, the best way to address this problem is to abolish the supplementarity requirement and permit countries to take advantage of the flexibility mechanisms as they choose. Even if the concept of supplementarity is retained as encouragement for countries to reduce greenhouse gas emissions domestically, it should be left to the State parties to decide what portion of the reduction efforts will be allocated to domestic actions. Too strict a definition of supplementarity would practically prohibit the efficient operation of the flexibility mechanisms.



The above discussion concludes that developing countries may join the Kyoto Protocol with binding reduction targets if the new method of setting reduction targets is adopted and corrective measures for the flexibility mechanisms are made. Such an approach will be equally acceptable to Korea, which will be assured of the sustained economic growth and benefit from the sale of surplus reductions with the active use of the flexibility mechanisms. However, to be allowed more time to study how the recently finalized flexibility mechanisms will work in practice, Korea must take a two-stage approach as outlined below.

In stage one, Korea would join the Kyoto Protocol as a non-Annex B country without any reduction targets, preferably in the second commitment period of 2013-2017, but any time before the third commitment period of 2018-2022. This would provide the nation with enough time to research and develop emission reduction technology and to test its capability abroad. Even the use of the technology in overseas projects would not bring any immediate emission reduction credits to the country because projects implemented by a non-Annex B country are outside the scope of either Joint Implementation or the CDM. However, such a preparatory measure would be important because Korea would find it easier to reduce greenhouse gas emissions in future commitment periods if sufficient technological build-up were already made.

In stage two, Korea would accept binding reduction targets for the third commitment period of 2018-2022 and actively use the flexibility mechanisms, under the condition that the dynamic target-setting method linking reduction targets to economic growth rate should be adopted. In this way, Korea could fully enjoy the cost-effective means of emission reductions and the prospect of business opportunities, while the dynamic targets would allay concerns on economic growth.

implementation, and the proposed value of the index was 151.5.(165) Argentina also requested that it be allowed to participate in the trading mechanisms, although it was not entitled to do so because of the country’s non-Annex B status.166

Such an approach clearly links emissions to economic growth rate, and it may be a reference for Korea when it seeks a formula for the binding reduction targets. However, to be seen as serious about reductions, Korea must reject the voluntary basis of the Argentine proposal and agree to the mandatory reduction target instead. The decision on the indexation method and on the value of the index would have to be made after a comprehensive assessment of the estimated long-term national economic growth rate and the GDP growth elasticity for demand of primary energy.

Some countries might oppose such a target-setting method because it appears too generous for Korea. However, unlike most developed countries whose post-industrial structure will allow less greenhouse gas emissions as their knowledge and service industries outgrow traditional sectors,167 Korea is still dependent on traditional industrial sectors that burn fossil fuels and will emit proportionately more greenhouse gases as the economy grows. If the Korean economy begins to slow down once its development enters the maturity stage, future reduction targets will naturally become more stringent and the nation may have to achieve more reductions as time advances. Therefore, the concerns about overly lax reduction requirements would not be applicable to Korea from a long-term perspective, and Korea could arguably fulfill its historical responsibilities in accordance with its contributions to the atmospheric concentration of greenhouse gases.

countries to stay opposed to Korea’s assumption of reduction targets linking emissions to economic growth.

That makes it indispensable for Korea to ally with other developing countries, especially China and India, and get their support in the drive towards the participation in the Kyoto Protocol under dynamic targets. Forming such an alliance will be possible if Korea successfully argues that national economic development would not be restrained under the emission reduction targets indexed to the economic growth rate. Moreover, Korea could obtain developing countries’ support by showing that, combined with the dynamic target approach, the flexibility mechanisms would bring sizeable financial resources into developing countries. In this context, Korea could be seen by both developed and developing countries as a model case that is willing to take on reduction commitments after having reached an intermediate level of development.

may be used as a forum to experiment with Korea’s strategy. In the short term, Korea will need to focus its diplomatic efforts on gaining support within the Environmental Integrity Group.


Participation in the Kyoto Protocol with dynamic targets will not benefit Korea automatically. Unless the country were fully prepared for new technological development, a commitment to the greenhouse gas emission reductions would cause significant costs throughout the entire nation, without any benefits from the effective use of the flexibility mechanisms. Apart from the command-and-control measures to cut down on its greenhouse gas emissions, Korea needs to take the following three measures to exploit the potential of the flexibility mechanisms before it becomes a party to the Kyoto Protocol with binding reduction targets.

First, as a preliminary matter it must set up a national system to prepare and manage the greenhouse gas emission inventory, which is a requirement for a State party with reduction targets in the Kyoto Protocol.172 As a non-Annex I party of the UNFCCC, Korea submitted its first national communication in 1998 and included a brief description of the inventory of greenhouse gas emissions and removals,173 which has not been updated since then. Because keeping an accurate record of greenhouse gas emissions would be essential if trading mechanisms were to be utilized, Korea would have to set high priority on the planning, preparation, and management of the inventory.174

emission reduction opportunities.175 Even if nations are willing to engage in such cost-minimization, they need to gather information on the cost-effective measures within their territories so that they may make cost-effective trades.176 In such a context, providing only for inter-governmental trading would mean that all firms would have to be subject to the ex ante reporting requirement and their governments would trade on behalf of their firms, which would likely involve excessive transaction costs and a longer trading process than trading between firms would incur.

Recently there has been a significant change of course in Korea’s environmental policy-making with respect to air pollution. In March 2002, the Korean Ministry of Environment reported to the President the annual environmental policy plan, which included a suggestion to introduce an emission allowance system for air pollutants such as nitrous oxide and volatile organic compounds (VOCs), starting as early as 2004.(177) More importantly, tradable emission permit schemes would also be established to help industries reduce pollutant emissions cost-effectively.178 Because many elements of such tradable permit schemes will be directly applicable to a trading system for greenhouse gas emissions, the Ministry of Environment intends to develop the permit schemes so as to accommodate greenhouse gas emissions trading in the future.179

This new policy appears to be in line with the recommendation that international trading mechanisms between firms should be implemented, and the Korean government must make it clear by issuing specific guidelines that domestic as well as transborder trading between firms will be allowed. However, because the Ministry of Environment does not retain sufficient political influence within the government to solely push a policy through that might conflict with other development-oriented policies, it needs to align with other constituents to strengthen its position. In this regard, Korean industries have a good reason to advocate such trading schemes, because they will offer cost-effective means to reduce greenhouse gas emissions and open new business opportunities to firms having fuel-efficient technology.180 Considering that Korean industries currently support the idea of domestic emissions trading,”” the Ministry of Environment will be able to strengthen its case for emissions trading by gaining industry backing.

gas emissions as an important factor in the goal-setting and implementation process. In general, changes in energy intensity, fuel substitution, and carbon coefficient are explained as main contributors to a decrease in greenhouse gas emissions.182 Therefore, Korea must shift its focus from traditional smokestack industries to industries of high value-added products, for instance semiconductors, electronics, and knowledge-based sectors, which produce less greenhouse gas emissions than heavy industry.183 Because a trend toward “knowledgeintensive growth” has been found in Korean industrial development,184 Korea needs only to emphasize the advantages of knowledge-based industries. In addition, substitution for fossil fuels by less CO2-intensive fuels would greatly enhance carbon emission efficiency,185 and the government must encourage more research in the area of alternative energy sources such as wind power and fuel cell technology. Considering that during the past decade CO2 emissions from road transportation in Korea have increased in volume as well as in weight,186 fuel cell technology could be an attractive option to explore. Policy measures aimed at inducing automakers to improve gas mileage would also deserve serious attention in this respect.187


Finally, to test whether the suggestions made in this chapter are acceptable for Korea, a summary of the suggestions was sent to each of the interviewees on May 9, 2002, and their feedback was requested. Among the five interviewees, two government officials responded by email the next day. Overall, their responses indicated at most partial acceptance of the suggestions.

half of 2002, without plans to reduce carbon dioxide emissions immediately.188 Such a decision perfectly matches the first part of the two-stage strategy, which recommended that Korea should join the Kyoto Protocol as a non-Annex B country any time before the third commitment period of 2018-2022.

However, even with the government’s decision, the question of whether and when Korea should accept binding reduction targets was left unanswered, and the two interviewees focused their feedback on the timing and formula of Korea’s assumption of reduction targets.189 The respondents showed approval of the approach made in the paper that the reduction targets for Korea should be set in a fashion to warrant its continuing economic growth.190 What they disagreed on was the modality of Korea’s reduction targets. One government official mentioned greenhouse gas intensity as a more favorable target for Korea,191 while the other official suggested that alternative target-setting methods should not be restricted just to the one indexing emissions to economic growth. 192 They were both silent on the timing of Korea’s assumption of reduction targets, which this Part suggested should be the third commitment period of 2018 to 2022.

Taken together, their reactions seem to suggest that Korea should do more research before deciding that any specific target-setting method is the most suitable one. Because more active feedback had been expected from the Korean policy-makers, the low response rate and their cautious approach were disappointing. However, they do not necessarily contradict this paper’s suggestions, and at least they confirmed that this paper has taken the right approach by stressing a new method of target-setting as a precondition for Korea’s participation in the Kyoto Protocol. It will be interesting to see whether Korea ultimately accepts the binding reduction target in a similar way as this paper suggests.


mechanisms as incentives for participation in the international agreement. However, because it was clearly shown that Korea would not join the Kyoto Protocol with the weakened potential of the flexibility mechanisms, this paper suggested in Part VI that the dynamic target approach should be an answer and in Part VII laid out Korea’s strategy for participation in the Kyoto Protocol. Korea’s situation as an economically advanced developing country would make its future path concerning climate change a good example for other developing countries to imitate, as they did concerning Korea’s economic development. If Korea’s first move encourages many developing countries to join the Kyoto Protocol, it may be a significant contribution toward collective action to address climate change.

The remaining question is whether and when the United States will return to the Kyoto Protocol and thereby stop wreaking havoc on the international community’s desperate effort to stem climate change. The United States might seek a new international convention as an alternative to the Kyoto Protocol, apart from its own domestic climate change policy.193 However, given the huge transaction costs expected to arise during renegotiation,194 a more reasonable approach would be to revise the Kyoto Protocol in such a manner that the United States’ interests might be well protected. Preserving and enhancing the costeffectiveness of the flexibility mechanisms would be one way, while getting developing countries to join the Kyoto Protocol would also ease the United States’ concern about burden-sharing. If the suggestions for improving the flexibility mechanisms made in this paper were accepted and major developing countries’ participation occurred, it could effectively refute the United States’ argument that the Kyoto Protocol is fatally flawed and build a ground for the United States’ return to the international agreement. In this regard, Korea’s leading role in facilitating other developing nations’ to join the Kyoto Protocol might incite criticism of the United States from other countries and within the United States that it is even lagging behind Korea, which has been thought of as strongly influenced by the U.S. foreign policy. This could be an impetus for the United States to reconsider its stance on the Kyoto Protocol. Because Korea’s participation in the Kyoto Protocol will begin after the European Union and Japan have ratified it, such a break with the conventional wisdom would carry less political risks for Korea than first presumed.

and the CDM could be another option to address equity concerns, because these mechanisms allow technological transfer from developed countries to developing ones in exchange for the reduction credits within developing countries’ territories. In addition, it was agreed at the COP-7 that several funds195 would assist developing countries in implementing capacity-building programs, and the transfer of technology resulting from the funds’ operation would be another desirable path in taking equity concerns into account.


* J.S.D. candidate, Stanford Law School; J.S.M., Stanford Law School; L.L.M., Seoul National University; L.L.B., Seoul National University. I would like to thank Professor Thomas C. Heller, Erik Jensen, Helen Stacy, and Jonathan Greenberg, at Stanford Law School, for their invaluable guidance and suggestions for this note. I am also grateful to Christopher Van Wyk and the editing staff of the Georgetown International Environmental Law Review for their tireless work in the editing process. Finally, I wish to thank my parents and Min-Jeong for their love and support.

Copyright Georgetown University Law Center Winter 2003

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