Concluding remarks

The main purpose of this chapter has been to elaborate on how differences in the economic structure among potential members of the Enforcement Branch lead to differences in the economic costs and benefits of sanctioning non-compliance. If a non-compliant country has a more than insignificant share of the total supply of quotas, suspending its eligibility to sell quotas will have impacts on the quota price and on the price differences between different fossil fuels and emission-intensive products. This will affect the economy of the enforcing countries. Imposing sanctions on a quota buyer may also affect the global economy if the country's excess emissions are large, because the sanctions will reduce the assigned amount for the second period. However, the imposition of sanctions on countries that deviate little from their emission commitments and did not expect to be large sellers of quotas would not affect the global economy, unless those countries withdraw from the agreement. If there is a possibility that a party found to be in non-compliance with its Article 3.1 commitments will withdraw from the agreement in response to the sanctions, the size of the sanctioned country's economy will influence the possible economic impact on the enforcing countries. A country that withdraws from the agreement no longer has to pay a price for the domestic emissions that result from the production of emission-intensive goods or the consumption of fossil fuels. The effect of a withdrawal on the international market for emission-intensive goods and energy grows with the market share of the sanctioned country.

All considered, it is clear that only when a small economy is considered for non-compliance can Enforcement Branch members be certain that they will not be economically affected. Since no enforcing country loses, the Enforcement Branch may easily reach consensus on imposing sanctions on small countries. When it comes to large non-complying countries, the members of the Enforcement Branch could have conflicting interests. As shown in the example in the preceding section, it is possible that sanctions will be imposed on a large non-complying country by one specific composition of the Enforcement Branch but not by another, if the members of the Enforcement Branch act in the economic interests of their own countries.

Another feature of the sanction mechanism that could be regarded as problematic is that sellers and buyers of quotas are treated unequally when considered for non-compliance. Since only sellers can be suspended from trading quotas, a non-compliance finding would have stronger economic consequences for sellers than for buyers. The latter could only be sanctioned in accordance with the first sanction mechanism.

Thus the deterrent effect of sanctions varies according to whether the non-complying country is a small or large quota seller, whether it is a seller or buyer of quotas, and the composition of the Enforcement Branch. The sanctions may have a moderate deterrent effect on both buyers of quotas in general and on large quota sellers, which see that imposing sanctions on them is not in the economic interests of the majority of the Enforcement Branch members.

When the members of the Enforcement Branch take national interests into account, it is worth exploring under which circumstances, and how exactly, they do so. Even if the interests of their own countries have an impact on the decisions of the members, these members might take into account more than just economic interests. A member of the Enforcement Branch could also consider the political interests of his or her country. For instance, if evidence of non-compliance is strong, an Enforcement Branch decision to the contrary could undermine the whole compliance system and the agreement itself. Also, a member could take into account the environmental damages associated with climate change. Suspending a non-complying country from selling quotas could lead the non-complying country to withdraw from the agreement and the damages from emissions of GHGs would increase, both because this specific country will do less, and because other countries might follow suit and withdraw as well.

The fundamental problem of the sanction mechanisms under the Kyoto Protocol is that what you can agree on behind the veil of ignorance could change when you get additional information on who is going to be sanctioned. Once the veil is lifted, members of the Enforcement Branch may behave strategically and impose sanctions not on the basis of the violation, but on the basis of how carrying out the sanctions may affect their own countries. This represents a significant potential weakness of the sanction mechanisms in the Kyoto Protocol.

Reducing the opportunity for strategic behaviour might strengthen the agreement. The current design of the sanction mechanisms is meant to serve two purposes: restitution and deterrence. By requiring that a non-complying country make up for its insufficient emission reductions in the next period, environmental restitution is made. Requiring that the country multiply the amount by which it was deficient by 1.3 serves as a deterrent. Deterrence is also ensured by giving an economic disincentive through the threat of revoking a country's eligibility to sell quotas on the international market. However, an equally effective economic deterrent - and one that would not encourage strategic behaviour on the part of the Enforcement Branch -could be to define a penalty per unit of exceeded emissions independent of quota trading. For quota sellers, this amount could be deducted from their income from quota sales by holding back a certain amount from quota sales until the end of the commitment period when possible non-compliance is revealed.

However, not even this would completely eliminate the possibilities for strategic voting among the members of the Enforcement Branch. The restitution element, that is, the reduction in the assigned amount corresponding to the excess emissions in the first period, increases global emissions reduction relative to a situation without sanctions. Increased global emissions reduction affects the prices of quotas, energy and emission-intensive goods, and would therefore affect countries differently. Hence, it is unavoidable that lifting the veil of ignorance might lead to strategic behaviour. Furthermore, since countries can withdraw from the agreement when they face sanctions, members of the Enforcement Branch can consider the costs and benefits of a possible withdrawal when they make their decisions.

Perhaps the most effective way to reduce strategic behaviour would be to take measures to ensure the independence of the members of the Enforcement Branch so that political and economic interests do not influence their decisions. For instance, when a seat of the Enforcement Branch is up for re-election, that member might take into account the interest of the electors when he or she decides whether to sanction non-compliance or not. Designing the selection process for the members of the

Enforcement Branch by relying more on legal qualifications and more permanent positions would reduce this strategic element for the members. 22

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