Climate Policy after Copenhagen

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Karsten Neuhoff
25.1.2010
Climate Policy after Copenhagen
At the UN conference in Bali (December 2007), States agreed on a two-year negotiation process,
the ‘Bali road-map’. The roadmap was designed to culminate in an agreement on future
international climate co-operation in Copenhagen in December 2009. Yet the Copenhagen
Accord, three pages that were merely acknowledged by the UN General Assembly, did not live
up to this expectation.
The set of possible reasons include internal EU disputes constraining European leadership,
objections of the US to international commitments prior to the passage of US domestic
legislation, and the reluctance of emerging economies to put their cards on the table in the
absence of US commitments. More broadly, it was even questioned whether UN negotiation
procedures, developed to tackle armed or political conflicts between countries, were well suited
to foster global treaties.
However, possibly the major challenge for the negotiations in Copenhagen was a conceptual
one. The rapidly evolving scientific, economic, and political landscape has resulted in a paradigm
shift on the mechanisms for international climate co-operation, which had emerged during the
climate discussions at UN, G8, G20, and major economies’ meetings leading up to Copenhagen.
A shared understanding of the new approach will be essential to facilitate future co-operation.
The following five aspects contributed to the paradigm shift:
(i)
(ii)
(iii)
(iv)
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the perspective of the 1990s, as reflected in the Kyoto Protocol, was focused on
marginal mid-term emissions reductions in developed countries. Improved climate
science and the rapid growth of some developing countries require ambitious
emissions reductions in the medium term and a transformation of our economies to
reduce future emissions to fractions of today’s levels. International negotiations
now discuss medium term objectives and strategies that are consistent with agreed
long-term temperature stabilisation objectives;
20 years of global climate co-operation and national and regional climate policy
frameworks demonstrate that absolute emissions targets must be supported by
low-emission development strategies to: ensure consistency across sectors; ensure
short-term actions are compatible with long-term objectives; identify trigger points
for public programmes and policies; and outline opportunities for the private-sector;
the focus on carbon pricing that emerges from global emissions trading schemes has
been expanded. While exposing actors to the social cost of carbon is essential, it is
insufficient, by itself, to shift innovation and investment towards low-carbon
technologies, projects and activities. Hence comprehensive policies and
programmes also address institutional requirements, evolve regulatory frameworks
and provide technology support to facilitate low-carbon transformation; and this is
reflected in the requirement to report national actions emerging from the
Copenhagen accord;
the emphasis upon supporting mitigation action in developing countries has shifted
from carbon markets towards public finance mechanisms. This reflects the need to
for clear, credible and long-term policies, as pointed out by the Copenhagen
declaration of 186 investment institutions, representing assets of US$13trillion.
Markets are an essential component – but they must be anchored in domestic
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policy frameworks, rather than imposed by international mechanisms which try to
limit engagement with domestic institutions;
the scope of monitoring and reporting is significantly increased. Medium-term
emissions targets in developed countries and off-setting (CDM) projects in
developing countries have resulted in a focus on the measurement of annual carbon
emissions. The new objective of low-emission transformation of our economies can
only be achieved with detailed information on the structure and implementation of
policies and programmes and private-sector response. Thus governments can
manage the implementation of policies and programmes, and rapid international
learning is facilitated.
While some of the objectives and approaches of international climate policy co-operation have
changed, co-operation remains essential for creating a shared sense of action and responsibility,
to provide outside commitments to translate longer-term objectives into short-term actions, to
provide support for mitigation and adaptation action in developing countries and to ensure that
the various parts of the global effort add up to achieving the global climate objectives.
The reminder of this paper explore how the evolving experience and assessment of domestic
implementation of climate policies in general, and carbon pricing as one specific example, is
reflected in emerging frameworks for global climate co-operation.
1. The role of a climate policy mix
Carbon emissions from energy production and industrial processes are deeply entrenched in
our economies. To mitigate the risk of catastrophic climate change, these emissions need to be
reduced to a fraction of today’s levels. In 2007, the Intergovernmental Panel on Climate Change
(IPCC) concluded, based on the scientific evidence it collected, that global CO2 emissions must
be reduced to half of today’s levels by 2050, to limit the risk of temperatures increasing above 2
degrees Celsius (IPCC 2007). The challenge is now to implement policy instruments to deliver
the necessary emissions reductions.
Many of the past climate policy discussions focussed on marginal emissions reductions. To
achieve these, economists recommend exposing producers and consumers to the
environmental cost of carbon, thus creating incentives for efficiency improvements and for less
carbon-intensive production and consumption choices. The theoretical foundation of this
approach is in the first fundamental theorems of welfare economics: The ‘invisible hand’ of the
market will result in efficient production and consumption decisions. It requires that a set of
assumptions is satisfied, including market participants' exposure to the costs of environmental
externalities. Carbon taxes or emissions trading therefore received much of the attention in
public debate.
The objective of climate policy has now shifted, from delivering marginal emission
reductions, to facilitating a low-carbon transformation of our economies. This requires revisiting
whether all the assumptions required for the first fundamental theorem of welfare economics
are still satisfied: e.g. whether internalising the cost of carbon will result in efficient market
outcomes. Ample evidence and analysis has demonstrated: that innovation and learning by
doing create non-convexities in cost functions; interactions between actors and technologies
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create network effects that result in non-convex benefit functions; and historic infrastructure
creates additional path dependency. All of these instances violate the fundamental assumptions
of the welfare theorem and therefore there is no theoretical foundation for claims that carbon
pricing on its own will result in efficient outcomes.
The Stern Review (2006) on climate change points to three sets of instruments which are
necessary to facilitate a low-carbon transition: (i) putting a price on carbon; (ii) technology policy
and targeted regulation, with transparent and shared information; and (iii) targeted measures to
engage individuals and firms in low-carbon opportunities. The design of any such public policy
intervention risks distorting economic incentives, creates agency costs, has distributional
implications and might intervene in private-sector decision processes. Hence it is essential
carefully to assess the specific situation of sector, country and industry structure when designing
the policy mix for the low-carbon transformation.
Changes to policy frameworks, in particular if a change directly changes relative prices of
products and services, have distributional implications that shift costs and wealth between poor
and rich, rural and urban parts of society. As a result, implementation of individual climate
policy instruments can increase or reduce fuel poverty or inequality in a society. The more
ambitious the objectives of climate policy instruments are, the more likely it is also that they will
result in significant distributional impacts that affect equity issues and political support. With
careful analysis, it is possible to anticipate many of these impacts, and to use complementing
policy measures to balance the implications, or to support individuals and firms during a
transition.
To illustrate the type of analysis that is necessary for any policy instrument, we briefly
explore the carbon pricing. Carbon pricing increases the price of processes, products and
services that are carbon-intensive, thus creating incentives for the use and innovation of more
carbon-efficient technologies, and inducing substitution towards lower-carbon fuels, products
and services by industry and final consumers. The price signal feeds into individual decisions that
would be difficult to target with regulation. Pricing also makes it profitable to comply with
carbon-efficiency regulations, thus facilitating their implementation. Carbon prices can be
delivered with a carbon tax or cap-and-trade schemes.
As much as the theoretical features are essential, the real analytic and policy challenge
evolves around the process of implementation of the relevant policy instruments and the design
of detailed provisions.
2. The delivery of investment responses.
Low-carbon transformations require diffusion of existing and new technologies,
infrastructure, and business models. A group of 186 investment institutions, representing assets
of US$13 trillion, announced in Copenhagen that this requires clear, credible, and long-term
policies. Over recent years, the paradigm on the framework, process, and mechanism to deliver
this low-carbon investment framework has rapidly evolved:
International discussions, for example of the Kyoto protocol, focused on emissions targets,
initially for developed countries. The expectation was that clear commitments to such targets
allow private actors to anticipate future opportunities, for low-carbon processes, products and
services, as well as constraints for carbon-intensive investment choices. The emission targets for
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countries obviously must be translated into policy instruments if they are to affect investment
choices of private actors. Cap-and-trade schemes directly translate emissions targets into
economic incentives for private actors. This can limit the uncertainty of policy design and
implementation and thus strengthen the low-carbon investment framework. The first example
of this approach – the EU ETS – has succeeded in focussing the attention of carbon-intensive
industries and their investors on exposure to carbon costs and on low-carbon opportunities.
When evaluating individual projects, many investors remain concerned that the carbon price
signal is not sufficiently robust and carbon prices might drop in response to economic and
political developments. It is therefore often argued that the risk of extremely low carbon prices
must be reduced, if low-carbon projects are to be facilitated. It was suggested that, for example,
carbon taxes would be more predictable in the short-term, and could thus increase investment
certainty for investors operating with short investment horizons. In the long term, however,
carbon taxes are more difficult to predict, as they are subject to continued political negotiation.
Even where carbon taxes are fixed in the long term, this might increase rather than reduce
exposure for low-carbon investors, who are competing in a world with uncertain fuel,
commodity and technology costs. The discussion illustrates that the variety of participants in our
economies might well respond differently to policy instrument that delivers a carbon price.
Hybrid cap-and-trade schemes, combining a price floor with an emissions cap, could target the
needs of heterogeneous groups of investors.
The evolving focus of climate policy, from marginal emissions reductions towards lowcarbon transformation of economies, is also reflected in discussions about low-carbon
investment frameworks. Investment in new technologies, production processes, products, and
services can only succeed with appropriate infrastructure, institutional setting and social
acceptance. It often requires government support for research, development and early
deployment, and adjustments to regulatory frameworks, and administrative standards and
procedures. The co-ordination of all these activities requires a shared vision of a country's lowemission development trajectory.
For this reason, the international discussions leading up to Copenhagen increasingly
emphasised the importance of low-emission development plans for developed and developing
countries. The plans characterise industrial and technological development, energy use and
emissions across different sectors of the economy. They can therefore ensure that initial
mitigation efforts are consistent with long-term objectives (e.g. understanding the implications
of efficiency improvements of coal power stations relative to other mitigation options). They can
also ensure consistency of mitigation strategies across sectors, for example by testing whether
available bio-mass resources is consistent with their anticipated use in steel, cement, transport,
heating, industry and power sectors, and by assessing whether electricity use in transport,
industry and for heat pumps is consistent with anticipated generation and network structure. In
addition they allow national governments to prioritise actions according to long-term relevance
and lead-times, and signal a consistent overall strategy to facilitate private-sector investment.
Low-emission development plans are therefore essential, not as a bureaucratic instrument,
but as a process to create a shared vision and platform to discuss and initiate the appropriate
policy actions and thus facilitate low-carbon investments. These actions might well differ across
countries that differ in their social preferences, industry structures, finance sectors, and
institutional settings. Countries might vary in their emphasis on short-term insurance of robust
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carbon prices, mid-term emissions targets translated into emissions trading schemes,
technology support schemes and institutional design choices and administrative standards
3. Opportunities for international climate co-operation
The discussion of domestic policy frameworks to facilitate a low-carbon development points
to the various opportunities for international climate co-operation. An adequate response to
climate change requires action on a global scale. The objective of holding the increase in global
temperature to less than 2 degrees Celsius (Copenhagen, 2009) requires a reduction of global
carbon emissions globally by at least 50% (G8 statement at Tōyako, 2008). Thus the main driver
for global climate co-operation will remain the engagement of all nations, in supporting
emissions reductions with their domestic efforts.
Sometimes the need to act on global scale, to achieve the 2 degrees Celsius target, is
interpreted to mean that individuals and countries have no responsibility to act individually in
the absence of adequate action at global scale. This is wrong – every tonne of carbon emissions
accelerates climate change and increases the risks and costs for our societies. Domestic
mitigation action does not require the justification or motivation of international co-ordination.
Some economists argue that individuals only consider the damage their carbon emissions
create and impose on themselves. According to this argument, national governments would,
equally, only choose mitigation action to the extent that these reduce future damage for their
own country. This line of argumentation would imply that climate change can only be tackled if
a comprehensive and enforceable global contract is signed. However, if this assumption of
economists would really be true, then we should observe that the only punishment constrains
individuals from stealing from their neighbours and only fear of retaliation restrains nations
from initiating wars. Fortunately, individuals and nations usually have a sense of empathy,
responsibility or morality and we often observe behaviour and climate change action, which
undermine this self-interest argument.
If international agreements are not essential to facilitate action of individuals and nations,
they can nevertheless be important to enhance the effectiveness of domestic action in
developed countries and, as will be discussed in the next section, to initiate international
support for low-emission development in developing countries. First, global co-operation can
enhance the level of understanding of climate change impact and options to tackle it, bringing
together experts and allowing policymakers and industry actors to a discussion of equals.
Second, joint global action reinforces a sense of individuals' and countries' own responsibility
based on perceptions of individuals' and countries' own behaviour and behaviour they observe.
Third, international co-operation can contribute to comprehensive reporting, so as to allow
rapid international learning on best practice policymaking, to facilitate measurement of the
performance of policy instruments, and to enhance accountability of policymakers and to
enhance transparency for private-sector investors.
International co-operation can furthermore provide a platform for commitments towards
emissions targets and specific actions, for example with regard to deployment of renewables.
Such commitments provide time frames and quantitative reference levels that subsequently can
help to overcome domestic political barriers. External commitments can also enhance the
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credibility of longer-term strategies for private-sector investors, reducing capital costs and
enhancing the scale of low-carbon investment.
This leads to the question of whether different countries should implement a joint emissions
trading scheme. Such a scheme can allow traders to identify the least-cost emissions-reduction
opportunities in a bigger market, and could therefore offer the benefit of reducing costs of
climate policy. A joint scheme also has some political attractions: it might reflect increasing
commitment of participating countries and could create momentum to drive implementation
through adverse political circumstances. Yet these benefits of a joint scheme must be weighed
against three potential drawbacks: First, if two countries have a joint scheme, but negotiate
future emissions targets separately, then industry in the more ambitious country will end up
buying allowances issued from the less ambitious country. This creates strong incentives to
negotiate less ambitious targets at any future negotiations. Second, emissions reductions
require a multitude of domestic policies, such as information provision, performance standards,
and suitable regulatory frameworks for new technologies. The responsibility of governments for
these policies is clearly defined, if targets are defined for the same jurisdiction over which
governments have responsibility. This allows governments to measure and manage policy
success more effectively, which is more difficult in the case of joint schemes which extend
beyond the boundary of their jurisdiction. Third, if domestic support in a country allows for a
more ambitious climate policy, this directly translates into a tighter cap for a regional scheme,
and results in higher carbon prices. The region will benefit from accelerated low-carbon
innovation and transformation. As the new low-carbon processes, products and policies diffuse
to other regions, they contribute to accelerated global decarbonisation. With a joint scheme, an
individual country's more ambitious target only will have a marginal impact in the scarcity of a
global scheme, and thus have a less significant impact on technology development and
transition.
Rather than designing a joint emissions trading scheme, countries could initially develop
individual schemes that are subsequently linked. Currently, separate emissions trading schemes
are evolving in Australia, New Zealand, and the US, while EU countries have implemented a joint
trading scheme. Several approaches are available that could result in direct and indirect linking
of these schemes. It is for policymakers to decide whether to pursue early integration, for
example in 2015, as proposed by the European Commission, or to delay such linking until 2020.
4. A world of different carbon prices
If national emissions trading schemes are not linked until the next decade, and if some
developing countries are slow in even implementing some level of carbon prices, then we are
facing, a world of differentiated carbon prices. Asymmetric prices frequently raise concerns
about carbon leakage: higher carbon prices might induce some industries to shift production or
investment to countries with low or no carbon pricing. Rather than reducing emissions, the
climate policy would result in a relocation of emissions to another jurisdiction, a phenomenon
typically described as carbon leakage.
The direct environmental impact would likely be negligible unless significant transport
emissions are implied, as the new production location is likely to have similar or better carbon
intensity as old facilities. However, there are three indirect effects which are quite
disconcerting. First, if emissions that are initially covered under a cap are relocated to another
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jurisdiction, this creates space under the cap for additional emissions, resulting in a net
emissions increase. Second, as the relocated production facility will not face the carbon price,
prices for carbon-intensive products will not increase and thus incentives for innovation and
substitution to low-carbon alternatives are suppressed. Finally, given the coincidence of
negative social, economic and environmental impacts associated with such relocation, policymakers are likely to address any potential risk of leakage by subsidies through free allowance
allocation or direct financial support, thus further undermining incentives for de-carbonisation
and potentially creating administrative barriers for any change to low-carbon processes,
products and services.
However, it is important to note that cost increases from carbon pricing, relative to other
cost components, are trivial for all but 1-2% of economic activity. As the cost increase is
concentrated in a narrow set of economic activities, in our analysis 24 sub-sectors, it is possible
to make a sector-specific analysis to assess whether the increase is really substantial. Due to
transportation costs, product differentiation, and sunk-investment costs, there is no concern
about leakage in several of these sub-sectors. Thus only a few sub-sectors, such as basic steel
and cement production, are likely to require targeted measures to address leakage concerns.
These measures can differ across sub-sectors and can include conditional free allowance
allocation, direct financial subsidies and border adjustments. Frequently a fourth option,
sectoral agreements, is proposed as a means of delivering a global carbon price for individual
industrial sectors; this also addresses leakage concerns prior to the establishment of a global
carbon price. All options have significant negative side effects, and should therefore be applied
as restrictively as possible. If these measures are implemented as components of an
internationally co-ordinated approach, some of these negative effects can be reduced. Close
international co-operation will therefore be essential to ensure any response to leakage
protects the environmental effectiveness of carbon pricing.
The sector-specific analysis of leakage concerns leads to the conclusion that it is possible for
countries to pursue ambitious emissions targets and make use of the full carbon price as part of
their policy mix. Thus leading by example, they can help to accelerate technology development
and diffusion, and contribute to international experience with low-carbon policy frameworks.
Individual action, however, is not a substitute for an international agreement that reflects
common but differentiated responsibility for climate mitigation and thus creates the
opportunity, and where necessary support, for all countries to contribute to emissions
mitigation action.
5. International support for low-carbon growth in developing countries
Developing countries are in a particular situation. Fewer historic emissions are reflected in
less current infrastructure and resources, while there are other pressing priorities, such as
poverty alleviation, education and health.
In recent years, the Clean Development Mechanism has been the major mechanism for
international support of low-carbon action in developing countries. It is a project-based offset
mechanism which allows industrialised countries to acquire emission-reduction credits
generated through projects in developing countries. It has the double aim of generating lowcost emissions reductions and promoting sustainable development in the countries hosting
projects. With financial flows directed towards developing countries, it has provided tangible
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evidence of the importance attributed to climate policy in Europe and Japan. It has succeeded in
supporting initial projects and has been effective in creating awareness, interest, and expertise
in both private and public sectors.
The CDM offsetting mechanism has also put a price on carbon. However, it acts as a subsidy
for low-carbon options, as opposed to providing a disincentive to choose carbon-intensive
options. As each tonne of avoided carbon emissions receives the same CDM price, the
mechanism creates profits for actors in energy- and carbon-intensive sectors in developing
countries, contributing to a lock-in of energy- and carbon-intensive activities, rather than
facilitating a shifting towards low-carbon development.
The mechanism exemplifies the paradigm of delivering marginal emissions reductions
through global mechanisms, largely circumventing the involvement of domestic policymakers
and institutions. It even creates incentives for policymakers in developing countries not to
implement effective domestic policy frameworks for low-carbon investments: China does not
receive further support for wind power projects after the national government implemented a
feed-in tariff.
Experience and analysis from developed countries show that effective domestic policy
frameworks are essential to facilitate a low-carbon transition. Hence discussions on
international co-operation on climate policy in 2009 have increasingly focused on shifting to a
new approach (see e.g. the text of the ad hoc working group on long-term co-operative action,
discussed at Copenhagen). This comprises four distinct components:
(i) Low-emission development plans were initiated by South Africa and subsequently also
developed by India, Brazil, China and Mexico. They outline the intended economic, energy,
and emissions trajectories for their respective countries. They cannot, and should not, be
the basis for any financial support (other than technical assistance for their development) or
definition of emissions targets for developing countries. The purpose of the overall strategy
is to identify trigger points for policy intervention. To initiate such policy intervention, lowemission development plans must be anchored in domestic policy frameworks and must be
developed with full domestic ownership. The shared ownership of low-emission
development across ministries provides information, capacity, and co-operation to identify
and implement NAMAs.
(ii) Nationally Appropriate Mitigation Actions (NAMAs) comprise a set of projects, programmes
and policies to shift a domestic sector or technology onto a low-carbon development
trajectory. This allows for a set of actions to be pursued in parallel to facilitate a shift to lowcarbon development of a sector or technology, including: training, capacity building,
evolving institutional and regulatory structures, and initial access to finance. The design and
implementation of NAMAs require local knowledge and political support from local
stakeholders The actions and associated politics for a low-carbon transition in any one
sector or technology are complex. Therefore it is desirable to define one NAMA for each
transition in a sector or technology, rather than further increasing the scope of a NAMA, as
this could delay delivery.
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(iii) International support mechanisms can provide tailored support for individual actions. They
must be easily accessible by motivated domestic stakeholders, to allow domestic and
international actors to structure support. This ensures that the support is demand-driven,
incorporates local insights, and tackles the specific needs of the country and sector or
technology. Different support mechanisms can create synergies for the implementation of a
NAMA: Capacity-building enhances skills to manage, construct, maintain, and operate new
technologies and practices which receive regulatory, financial and technical support.
International support can enhance the scale, scope and speed of implementation of NAMAs.
If support is linked to individual NAMAs, it creates an additional driver for the domestic
implementation of the actions required for success. Linking the support to continued NAMA
implementation enhances the stability of regulatory and policy frameworks. For example, a
feed-in tariff is more likely to be stable if international support contributes to the
incremental cost over time. This attracts domestic and international manufacturing and
investment.
Technology co-operation can support the development of an enabling environment for lowcarbon technologies, encompassing technology innovation, human and institutional
capacity, markets and regulatory frameworks, availability of finance, and focussed national
policies. The type of support must be tailored to the state of development and diffusion of
the technology, and to the country's needs. While the mechanisms often focus on cooperation between governments, their ultimate objective is usually the creation of an
enabling environment for private-sector innovation, deployment and use of the
technologies.
Financial instruments matching the needs of actors and sectors facilitate the
implementation of NAMAs. Grants, loans, credit guarantees or equity funding can thus
support public and private actors in dealing with the risks of new technologies and policy
frameworks, and create opportunities to acquire new skills and develop business models.
International support for individual NAMAs can facilitate their implementation and enhance
their long-term credibility. Public finance is therefore an essential catalyst to shift large
volumes of private-sector investment to low-carbon technologies.
The choice of financial instruments needs to reflect institutional capacity and available
resources. Experience of bilateral and multilateral co-operation for specific financial
instruments can inform the choice of institutions for their provision. The resource base of
multilateral institutions can be strengthened with revenue from carbon pricing on
international aviation and shipping. Commitment to hypothecation of domestic carbon
revenues can create the public funds necessary for bilateral co-operation. If all support
provided across all instruments were measured in grant-equivalent terms, developed
countries’ contributions could be evaluated against their commitments (the Copenhagen
accord indicated US$ 100 billion).
(iv) Expanding monitoring and reporting beyond greenhouse gas emissions can enhance the
implementation of an action or policy, facilitate international learning, and create
transparency to support private-sector investment and innovation. This requires detailed
quantitative and qualitative evidence. It reflects the experience from industry and other
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sectors that points to the need to link outcome measures (like changes in greenhouse gas
emissions) to a combination of input, process and output indicators.
One conceptual challenge for the year 2010 will be the design of transition from a CDM
mechanism to a broader support framework for low-emission development. A clear and shared
vision of such a transition is necessary, to avoid CDM interest groups delaying new approaches
that are not in their specific interest, while failing to attract investment for their own projects
during a time of policy uncertainty. Well handled, the expertise and structures that were
developed to explore, pursue, monitor and finance low-carbon projects under the CDM
mechanism can be redirected towards the design and implementation of NAMAs and the
pursuit of low-carbon investment in the new framework.
6. Conclusion
National and international climate policy rapidly evolved in 2009. From a static analysis,
focussed on delivering marginal emissions reductions, the focus has expanded to facilitating a
low-carbon transition. This requires an extension of policy instruments, from simple carbon
pricing towards policy packages tailored to the specific needs of countries and sectors.
The importance of low-carbon transformation as part of an adequate response to climate
change is reflected in international climate negotiations. The focus has shift from a top-down
approach, of target-setting to trigger domestic action, to a bottom-up approach that explores
how domestic policy design and implementation can be supported through international
cooperation.
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