Discussion Paper

Using Virtual Options to Turn "CO2lonialism" into "Clean Development"

Dec 31, 2005 | Urvashi Narain, Klaas van 't Veld


It is widely recognized that industrialized countries’ commitments under the Kyoto Protocol toreduce their greenhouse-gas emissions will be far less costly to achieve if they can be met at least inpart through investment in cheap abatement options available in developing countries. Developingcountries have been reluctant to permit such investment, however, out of concern about the so-called“low-hanging fruit problem.” The standard characterization of this problem is that if developingcountries allow their cheap abatement options to be used now, they may find themselves worse offin future when they take on emissions-reduction commitments of their own, because only expensiveabatement options will remain. We show that under plausible CDM-market imperfections a lowhangingfruit problem may indeed arise, but that the standard characterization of the problemis incorrect. We also propose a simple solution, based on mandating a “virtual” option clause inCDM-investment contracts.