The Analysis of Country-to-Country CDM Permit Trading using the Gravity Model in International Trade

Abstract

The fairness and effectiveness of the Clean Development Mechanism (CDM) in reducing greenhouse gas emissions (GHG) and promoting economic development is a matter of substantial concern for the international community as it works towards another GHG reduction agreement in Copenhagen. Among other reasons, the CDM has been criticized as favoring some countries and disfavoring others, resulting in an imbalance in the distribution of development projects, thus undermining one of the original purposes of this institutional arrangement. In this paper, we evaluate CDM projects using econometric models based on international trade theory. We conclude that while the CDM suffers from such imbalance, the primary determinant of CDM projects is the total GHG emissions from host and credit countries. GHG emissions in each were positively and consistently related to the CDM projects. The degree to which a country engages in international trade (“openness”), the extent of its infrastructure (such as road, rail lines, telephone and internet connections) and whether a former colonial relationship exists between the host and credit country were each important determinants when we considered all CDM projects, but not significant when we analyzed only accepted projects. We calculate that if the degree of openness increased from 25 to 75 percent, the host country could attract 73% more CDM projects, while a similar increase in infrastructure, would result in 4% more projects. Our paper indicates that while the geographic distribution of CDM projects is skewed toward large counties, it appears to be a response to current environmental, economic and domestic policy considerations. We conclude by discussing these results in the context of policy-based action that might limit or otherwise affect CDM implementation after the Copenhagen.