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I'm sure we've heard it all: Global-level mass-extinction, famine, war, disease, natural disasters, basically an apocalypse waiting for us if we don't reduce carbon emissions to halt global warming (climate change), and it's coming sooner rather than later.

However, it appears the political leaders of the world (the whole world) believe that global warming is a problem that the first-world countries can simply throw money at and it will go away. Cap and Trade is one such philosophy. From Wikipedia:

A central authority (usually a governmental body) allocates or sells a limited number of permits to discharge specific quantities of a specific pollutant per time period. Polluters are required to hold permits in amount equal to their emissions. Polluters that want to increase their emissions must buy permits from others willing to sell them. Financial derivatives of permits can also be traded on secondary markets.

The "cap" part of "cap and trade" makes sense: if we want to reduce emissions, then we should limit how much emissions we can tolerate to reduce global warming. It's the "trade" part that bothers me. My particular concern is as such:

Firstly, let us assume that countries pollute at vastly different levels. This could be caused by any number of things, including but not restricted to:

Land mass: A larger country can hold more factories, and therefore produce more emissions.

Economy size: A country with a larger/more prosperous economy has more people employed (in raw numbers) and some of those people are involved in professions which increase pollution.

Stage of development: Poorer countries may not have the technology required to build greener technologies, or the expertise to use green technologies which already exist.

Economy type: Economies built based on e.g. manufacturing will pollute more than economies built on e.g. tourism.

And so on. However, my understanding is that carbon credits are distributed to countries irrespective of these factors. To apply a bit of game theory, there appears to be two solutions to this conundrum (in which this is a sliding scale, not a dichotomy):

  1. Pollute less. This could include things such as increasing education/R&D to develop greener technologies, or simply shutting down businesses which pollute too much.

  2. Buy carbon credits from other countries who pollute less.

Since option 1 might be very politically inexpedient (telling a large manufacturer to shut down 20 plants is probably not going to fare well next election cycle), option 2 is the most expedient. In which case, it seems to me, the result of cap and trade is simply a money-funneling operation from countries which rely highly on high-emission industries to countries which do not, without meaningfully impacting actual greenhouse gas emissions.

Now, my questions are as follows:

  1. If we believe global warming to be a global extinction level event, why do we allow the "trade" part at all? Why not simply "cap"? If you are a country who misses your targets, you get sanctioned, e.g. by international tariffs of countries refusing to buy products produced by inefficient manufacturing, etc., until you get your emissions down.

  2. If we allow the "trade" part of "cap and trade", why do we not simply allocate emissions targets using a method more realistic to the states of various economies? E.g. If the USA gets 50 carbon credits and uses 70, and Norway gets 50 credits and uses 20, why not instead allocate 75 credits to the USA (allowing them to use their 70 credits with 5 left over) and Norway gets 25 (allowing them their 20 credits with 5 left over)? Why is a transfer of money necessary for this scheme to be effective?

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    1. Dooms-day experts don't consider global warming to be a global extinction possibility at all. We have a greater chance to be extinct from an asteroid. The reason is that we already HAVE solutions for global warming that are already implementable. Pollution is the much bigger issue. 2. This is no different from everybody mutually agreeing to cut their economy, not going to happen. The issue is that many countries are going to violate the agreement regardless. – Matthew Liu Feb 13 at 22:37
  • tl;dr; The idea is, that projects in 3rd world countries are cheaper, thus far more likely to be successfully implemented from an economic point of view. – hitchhiker Feb 13 at 23:26
  • Your example that has a cap and trade regime allocating the same number of pollution credits to the U.S. and Norway is unrealistic. You set up a straw man. – H2ONaCl Feb 14 at 1:33
  • In a capitalist society "simply throwing money" at things is the solution to things by design. A system of carbon credits and charges is playing to the strengths of the system. Of course whether things are banned or taxed seems quite arbitrary sometimes. Why are some drugs illegal, resulting in long prison terms while others are legal but taxed (and taxed more heavily to reduce usage rather than simply banning them). – Eric Nolan Feb 14 at 13:11
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More realistic numbers

If we allow the "trade" part of "cap and trade", why do we not simply allocate emissions targets using a method more realistic to the states of various economies? E.g. If the USA gets 50 carbon credits and uses 70, and Norway gets 50 credits and uses 20, why not instead allocate 75 credits to the USA (allowing them to use their 70 credits with 5 left over) and Norway gets 25 (allowing them their 20 credits with 5 left over)?

This is unrealistic. The actual situation is likely to be that the United States would get 325 credits and Norway would get 5, as the US has more than sixty times the population of Norway. Norway probably currently uses something like 9 credits and the US uses 1000. Source: World Bank; adjusted based on 325 million population in the US and 5 million in Norway.

Now, how is Norway, which has fought hard to get down to 9 credits of usage going to feel when it is allocated 6 credits (two thirds of what it is using) and the US is allocated 667 (two thirds of its usage). Norway has to seriously reduce its usage, even though proportionally it is only using 50% more than its share by population while the US overuses more than 233% of its proportional usage. But both have to cut usage by the same amount. The US would be overusing by more than 100% even after the reductions. Meanwhile, Norway would be overusing by 33%.

Since emission targets are essentially dependent on the countries themselves enforcing them, chances are that Norway would simply refuse. They'd insist on a more even split.

Without trade, emissions increase

Without the trade portion, emissions would move physically. A plant would close in the US and an equivalent plant would open in a country that is not using all of its cap. Along with that, manufacturing would move. For example, aluminum production is heavily dependent on electricity. So it will move where the electricity is available.

The emissions used to build the new plant are a dead weight loss. That increase is entirely unnecessary. We could save them simply by allowing the existing plant to continue operating. This is what trade allows. Existing plants can buy credits from countries that don't currently use all the emissions that they could.

Building renewables

It is much easier to produce renewable energy in some places. For example, the Sahara desert gets more sunlight per square foot per year than New York City does. Trade allows the Sahara to get 100% of its electricity from solar and batteries while New York City continues to be reliant on other sources. The countries in the Sahara can use the profits from selling their carbon credits to buy the solar and batteries.

Central planning

Trying to figure out all these numbers at one central location and then assign carbon credits appropriately is not going to work. It requires a full understanding of the preferences of the entire world population. Meanwhile, a market does this naturally. People communicate their preferences via the prices that they are willing to accept. The best case solution would be for the central planner to match what the market does. But the truth is that the central planner does not match the market. Central planners do noticeably worse, creating shortages (we only planned for 1 GWh of electricity; we used that in the first 25 days of the month; for the last 5, no electricity) or waste (albeit this is easier to handle).

  • Very good and thought out answer. Explaining why I still don't buy it is going to take a few comments. For your first point, comparing the US and Norway, that doesn't sound like a problem to me. The US has to reduce (in your scenario) over 300 units of carbon, while Norway has to reduce only 3. If Norway doesn't "like it", then Norway can experience the stick (whatever punishment the world body chooses to impose on those who violate the emissions policy). This is what "working together" means, everyone has to do their fair share. (cont'd) – Ertai87 Feb 14 at 15:27
  • Regarding your second point, I take as a true dichotomy that either emissions are acceptable, or they're not. Regarding the hypothetical plant in the US that might close and open somewhere else, if the plant is OK in the other place, then it should be OK in the US; either the plant is OK or it's not, anywhere. Furthermore, if the plant is not OK in the US, then why do we permit the plant existing provided that the US pays extra money for it? Once again, if I am to believe that global warming is an extinction-level event, we shouldn't allow it to continue by "paying it off" with money. – Ertai87 Feb 14 at 15:30
  • Regarding your 3rd point, that point seems off-topic so I won't bother addressing it. As for your 4th point, we have years of data of how carbon credits move throughout the world by buying and selling. A central planner can use that data to allocate carbon targets by region and allocate credits in a way that would loosely match the effect of trading. Pulling random numbers out of a hat, I agree, is inefficient, but we have lots of data and we can use it to build an efficient system. Perhaps such a system would have to allow trade to a small extent, but the current system is greatly worse. – Ertai87 Feb 14 at 15:32
  • @Ertai87 Your suggested regime sounds like a dystopia that contains a powerful administrator of a certain punishment and it also requires the central planner to be wise, objective, and un-corrupted. – H2ONaCl Feb 15 at 2:03
  • "if the plant is OK in the other place, then it should be OK in the US;" And that's what trading credits allows. Locating a plant in the US or somewhere else. And it can make that decision at any time. Your central planner can only look at historical information. Trading allows a balance with future information. – Brythan Feb 15 at 18:00
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If the pollution credit is worth $1 and I can cut my own pollution at a low cost of say $0.80 then I will spend $0.80 to cut pollution and sell the credit. I will then be $0.20 wealthier. Presumably the buyer of the credit can cut pollution at a cost higher than $1 so perhaps it is $1.20 to operate a little more cleanly. If the buyer pays $1.00 for the pollution credit then she avoids spending $1.20, so she is $0.20 wealthier. Both sides of the trade experience a benefit.

Different activities, businesses, and countries have different costs. For example if my country has inexpensive labor perhaps I can do more tourism and less steel exporting so I have an inexpensive way to cut pollution. Note it is not without cost because if my economy is already heavily tourist oriented, there must be a (costly) reason why it is not already even more heavily tourist oriented.

If the trade is illegal then the seller of the credit owns something valuable that it cannot sell which means a loss of sovereignty and the buyer has something valuable (money) and it cannot exchange it and that is a loss of sovereignty.

  • Your statement that both sides experience a benefit is relative to the current status quo, which I take as a premise is flawed. Compare to the status quo whereby countries are allocated carbon credits according to their needs: countries which "need to" pollute more, e.g. because that's how their economy is built, are allocated more carbon credits, while companies without need are allocated less. Associatedly, the "trade" part of "cap and trade" is abolished. Compared with that situation, your assertion benefits only the country selling, not the country buying. – Ertai87 Feb 13 at 21:56
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    @Ertai87 if every country has all the credits they need then there is no "cap". There will be a cap so there will be a shortage. Even if there is no shortage initially it will be a good idea to force a shortage upon everybody has their populations grow or even if their economies grow at a constant level of population. In other words, do not raise the cap as their economies grow. That forces a shortage upon them all. Even when all countries need more pollution credits there will be some sellers. – H2ONaCl Feb 13 at 22:02
  • Deleted my previous comment because it was too difficult to read. Basically, the point would be, there would be a two way agreement: The party adhering to the cap ("country") would agree that they have to reduce emissions under the cap, or face severe penalties (TBD). Conversely, the party assigning the caps ("cappers") would agree that the caps they create would not put the country under an undue, unrealistic burden to meet the cap. Therefore, you can create a "shortage" situation while being respectful of different environments and also eliminating the "trade" part of "cap and trade". – Ertai87 Feb 13 at 22:11
  • @Ertai87 It does not matter if everybody can make the appropriate adjustments to meet a negotiated reasonable target. It is a matter of instituting a better way. – H2ONaCl Feb 13 at 22:41
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If you want my opinion, the answers here so far either over complicate or slightly miss the mark. Aside from the question here’s a dirty little secret environmentalists like myself don’t want you to know, a cap and trade system and a carbon tax function the exact same and will acquire the exact same results in theory. We use cap and trade because it is more likely to win over fee market voters.

Anyways back to the question. There are two basic reasons for a trade system.

  1. It allows for the resources (pollution) to go to its highest valued use. This is a very fundamental principle of a free market, which this is trying to take advantage of. If someone produce x amount of gdp with 1 unit of a pollution, while someone else needs 2x to create it, the 2x will buy up more pollution and will result in more GDP. If someone is given 1 unit of pollution to use but the can use .75 unit of pollution and have close to the same gdp, this is good and we should not let that spare pollution go to waste.

  2. Trade breeds innovation. Simply put, if you find a way to cut your pollution in half and make the same amount, we should be glad you can trade it.

  • we should not let that spare pollution go to waste. Wasn't the initial goal to reduce pollution to minimum ? Not wanting to "waste" pollution seems like the exact oposite. – Bregalad Feb 14 at 8:00
  • Spare pollution meaning pollution within the bounds of what’s allowed. So if we can prevent global warming by only producing 100 units of pollution, we should want all 100 to be used and used efficiently – spmoose Feb 14 at 14:15
  • @spmoose I continue to fail to understand why we care about raising a country's GDP when doing so will cause an extinction-level event of the entire human species worldwide. Sorry, I still don't get it. Also, your suggestion that cutting pollution in half and then trading the excess seems very unrealistic; if such a technology existed which would allow a major polluter (to whom such a technology would matter) to cut their emissions by such a large margin, I'd expect we would have found it already given the amount of ongoing research. – Ertai87 Feb 14 at 15:20
  • @Ertai87 could you please explain what extinction level event you are referring to? Of humans? Other species? All species? And to your second point technology has been been consistently getting more efficient in terms of energy consumption. Since powering something costs money, companies want to spend less of it. Excess pollution does get traded efficiently in California’s cap and trade system. – spmoose Feb 14 at 19:08
  • @spmoose news.un.org/en/story/2018/09/1018852 <- "direct existential threat" in the title of this UN article in reference to climate change. Not sure who is being quoted there (the article doesn't seem to say), but if the UN is quoting it, it's probably someone reputable. – Ertai87 Feb 14 at 19:24
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If we believe global warming to be a global extinction level event, why do we allow the "trade" part at all? Why not simply "cap"? If you are a country who misses your targets, you get sanctioned, e.g. by international tariffs of countries refusing to buy products produced by inefficient manufacturing, etc., until you get your emissions down.

Ignoring the question if the cap and trade is on an international or country level, it makes sense to leave flexibility in the system which will mean that pollution is caused where most 'essential' I.e. where there is enough incentive to pay for it. To make arbitrary sector by sector limits would 'waste' pollution on less important things.

e'g. If the USA gets 50 carbon credits and uses 70, and Norway gets 50 credits and uses 20, why not instead allocate 75 credits to the USA (allowing them to use their 70 credits with 5 left over) and Norway gets 25 (allowing them their 20 credits with 5 left over)? Why is a transfer of money necessary for this scheme to be effective?

Your assumption that credits will not be maxed out without financial incentives out is flawed, especially as the point is to reduce overall emissions. A second false assumption is that initial quotas would not take circumstances into account.

  • I do not assume credits will not be maxed out without financial incentives. I simply picked numbers out of the air; if it would help to get my point across I would be happy to edit my OP to make the numbers match. However, in real life the numbers rarely match so I chose to leave some gap to make the situation more realistic. In any case, there would be financial incentives, of the form: "If you don't reduce emissions to an acceptable level, the rest of the industrialized world will tax/tariff your exports into oblivion", or something of that nature. – Ertai87 Feb 13 at 22:03
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If we believe global warming to be a global extinction level event, why do we allow the "trade" part at all? Why not simply "cap"? If you are a country who misses your targets, you get sanctioned, e.g. by international tariffs of countries refusing to buy products produced by inefficient manufacturing, etc., until you get your emissions down.

We allow trade because:
1) It increases efficiency
and
2) Not allowing trade isn't an option

1) If you want people to accept your proposed solution to climate change, you should have the highest effect for the lowest cost as possible. There is something in economics called "the efficient frontier". Imagine a two dimensional graph of all possible policies, with the x-axis being how effective it is, and the y-axis being how expensive it is. There would be some regions in that graph that represent some possible policy. For instance, the "reduce carbon emissions by one ton by spending one trillion dollars" point would probably be in the region. "Reduce carbon emissions by one million tons by spending one dollar" probably would not be. The boundary between those regions is called "the efficient frontier".

This will be some curve that will probably have positive slope: as the amount of desired effect increases, the needed expense will also increase. Different people will have different ideas about where on that curve we should be: some people might say that we should spend a little bit of money to have some effect, while others will say that we should be willing to spend a massive amount of money if it will have a large effect. But we should all agree that we should be somewhere on the efficient frontier. Getting below the efficient frontier is, by definition impossible. And getting above it is "leaving money on the table: if we're above the frontier, we can either move down (spend less money for the same effect) or move to the right (get more effect for the same money).

Any just-cap-don't-trade system is pretty much guaranteed to be above the frontier: if no one wants to trade, then the question of whether it's allowed is moot. If people do want to trade, then that means that there is some profit to be had by trading. More profit means the cost of the system is going down. And since emissions are capped, the effect is staying the same. So: less cost, same effect.

2) Even if we wanted to prohibit trade, we couldn't. Suppose, without credit trade, Country A would have more factories than its credits supports, while Country B has fewer. What will happen? The the companies in Country A will close down their factories there, then build new factories in Country B, then export the stuff the factories make back to Country A. Result: a bunch of carbon emissions from tearing down the factories in Country A, more from building the new ones in Country B, and even more shipping the products back to Country A. So unless we have an extremely protectionist trade system, prohibiting credit trade will result in the same effect, but at much higher cost.

Calculating the carbon footprint from a particular country's manufacturing is a pointless exercise. The world's economy is interconnected. There are things that are made in other countries that America consumes, there are things that are made in the US that other countries consume, and there are things that are made in other countries that the US uses to build products that are shipped to a third country. Are you going to try to pull apart the entire supply chain of the entire world, or are you just going to assign credits and let the economy sort it out?

If we allow the "trade" part of "cap and trade", why do we not simply allocate emissions targets using a method more realistic to the states of various economies? E.g. If the USA gets 50 carbon credits and uses 70, and Norway gets 50 credits and uses 20, why not instead allocate 75 credits to the USA (allowing them to use their 70 credits with 5 left over) and Norway gets 25 (allowing them their 20 credits with 5 left over)?

From a Coasian point of view, it doesn't matter. From a political point of view, you're basically rewarding countries for ramping up carbon emissions as high as possible right before credits are assigned. The primary criterion for assigning credits is going to be what's "fair". Different people are going to have different ideas about what is "fair", but whatever it is, it probably won't be the same as "however much the country is currently emitting".

Suppose Alice and Bob are on a ship the shipwrecks on a deserted island, and the first day they're there, Alice eats a bunch of coconuts. The next day, Bob says to Alice "There are only a limited number of coconuts on this island. We should split them evenly." Alice says "You don't even like coconuts! I should get all of them." Bob says "Just because I don't like them, doesn't mean it's fair for you to take my share. If you want my share of coconuts, you should offer me something in exchange." That's basically what the cap and trade system is: even if a country isn't using their credits, they're going to want something in exchange for another country using them.

Why is a transfer of money necessary for this scheme to be effective?

Because this isn't a command economy. Money is the means by which different participants in a market economy share information about the value of assets. By trading carbon credits, the market establishes a market price for carbon credits, which tell market participants whether their carbon emissions are efficient: if you can sell a product for more than the cost of the carbon credits that you have to buy to make the product, then your company is providing value to the economy greater than the damage of its carbon emissions, and so should continue. If you can't sell the product for more than the cost, then you are producing less value than the damage, and so you should stop. The market price of carbon credits provides a quantitative, object metric of what activity is a net positive, and what is not.

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Question 1: If we believe global warming to be a global extinction level event, why do we allow the "trade" part at all? Why not simply "cap"?

As the global emissions are simply defined by the cap component, one could say that there is no reason to trade or not to trade. Trade is irrelevant to the emission level which is exclusively defined by the cap (as long as the cap is low enough to have a restrictive effect).

Therefore, you might also ask "Why do we want to forbid trading, if it doesn't do any environmental harm?" As H2ONaCl perfectly explains both seller and buyer benefit from trade. Why should anybody be stopped from doing more in exchange for an adequate compensation?

Costs may vary significantly from country to country and industry to industry. In one industry the introduction of some cheap technology might reduce emissions by half, in another a reduction by three or four per cent would either be extremely expensive or even physically impossible.

Trade lowers the total cost to achieve a given emission level. This means that the citizens of the trading countries are wealthier than they would be in a non-trade environment.

Of course, it is possible to use some of these expected gains to set a more ambitious cap level.

Question 2: If we allow the "trade" part of "cap and trade", why do we not simply allocate emissions targets using a method more realistic to the states of various economies? E.g. If the USA gets 50 carbon credits and uses 70, and Norway gets 50 credits and uses 20, why not instead allocate 75 credits to the USA (allowing them to use their 70 credits with 5 left over) and Norway gets 25 (allowing them their 20 credits with 5 left over)? Why is a transfer of money necessary for this scheme to be effective?

Here you are touching another question: the allocation of the carbon credits. You seem to assume that every country gets the same number of credits: the USA, China or Saudi-Arabia receive the same number of credits as the Bahamas, Vanuatu or the Vatican.

The allocation was/is indeed a contentious issue. Two seemingly fair positions:

  1. "Every country has to reduce its emissions by the same percentage of its current level."

  2. "Every human has the same right to pollute earth. The carbon credits have to be distributed to the countries based on their population size (or directly to each human)."

The first position is opposed by poorer, less-developed countries who fail to understand why they should forever be obliged to pollute less - and live poorer - than those who have created the problem in the first place.

The second position is perceived as a lazy excuse by developing countries as they wouldn't be obliged to do anything (and gain from trading).

  • Your first point is good and convincing. However, I still posit that simply assigning the credits more efficiently is a better way than trading. Perhaps a limited amount of trading would be allowed in case of inefficiencies in planning, but the current system, which basically irons out all inefficiencies by way of trading, simply costs a lot of countries a lot of money for no discernable reason. If we make more educated emissions caps/targets, then trading can be mostly eliminated, and I see no good reason why that's a bad thing. – Ertai87 Feb 14 at 15:36
  • As for your second point, there are vastly more options available, such as bonuses for developing countries (who pollute more to develop faster), or bonuses for manufacturing hubs (whom, if punished too harshly, could damage the world economy), and so on. But aside from that, my rebuttal, as I've said elsewhere, is that if I am to believe that global warming is an extinction-level event, then every country should be more than willing to do whatever they can to help to the best of their ability, without opposition whatsoever. Failure to engage in complete compliance is not an option. – Ertai87 Feb 14 at 15:39
  • @Ertai87: "complete compliance" with who? Compliance is only possible in the presence of an international agreement or a "benevolent dictator". There is no dictator and an agreement requires an agreed understanding of burden sharing. The two presented options are based on very clear principles of fairness. In practice, you need to come to a compromise. Granting "bonuses" arbitrarily without discussions is no solution as there would always be 99 per cent, who think that your solution is neither just nor justified. – Frank from Frankfurt Feb 17 at 9:41
  • I agree in theory, for most cases of agreement. However, if I am to believe the current situation, we have proven via science that global warming 1) is real, 2) is manmade, 3) is preventable, and 4) is leading to an extinction-level event (or something almost as dire). In which case, anyone not doing their part is actively contributing to the extinction of the human race. "Complete compliance", therefore, is with the central authority handing out the carbon credits: you either adhere to your carbon allowance or face dire consequences for your nation. (contd) – Ertai87 Feb 19 at 15:29
  • "Compromise" is not really an option, because "compromise" in this case, leads to the extinction of the human race. The answer to any form of "compromise" is, "would you rather die? No? Ok, request for 'compromise' is declined". With regards to granting "bonuses", I fail to understand why dissent is a reasonable consideration. Again, the answer to dissent is "you don't like it? Fine, then you can die". Or am I mistaken in how dire the situation of global warming is? – Ertai87 Feb 19 at 15:31
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Great question! It does seem counter-intuitive that we could trade units of emissions, believing that all the emissions are bad. Why should any country with money be allowed to pay to benefit from another country's unused units?

The missing premise is the carbon cost of economic growth. Countries that aren't as well-developed as the US and Europe are increasing their carbon consumption each year, because that is the most cost-effective way to build a new hospital, schoolhouse, road, factory, office building, military, or large-scale farm.

Compared with selling emissions units, it seems just as unfair that a country with inadequate healthcare would not benefit from the same affordable growth that the US and Europe already completed, and so people don't want to appear heartless by preventing developing countries from using cost-effective forms of energy.

  • Fair enough. Then why can't those developing countries be allocated a priori more carbon credits to allow them leeway to grow their economies, rather than having to pay for them a posteriori? – Ertai87 Feb 13 at 21:58
  • As a second question (hence a second comment), while I agree that it is unfair to disallow a developing country from developing, a global mass-extinction event is even more unfair, not only to that country, but also to everyone else. Who cares if your economy sucks if everyone is dead? – Ertai87 Feb 13 at 22:00
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    Are you sure this is an answer to the question? It looks more like a comment than an attempt to answer. – H2ONaCl Feb 13 at 22:25
  • @H2ONaCl, the question was phrased as "why do we allow" and this is an attempt to answer that based on human motivations behind policy. – elliot svensson Feb 13 at 22:29
  • @Ertai87, who is claiming that carbon dioxide emissions will result in such a dreadful scenario? – elliot svensson Feb 13 at 22:43

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