The Clean Development Mechanism’s Low-hanging Fruit Problem: When Might it Arise,and How Might it be Solved?

It is widely recognized that industrialized countries’ commitments under the Kyoto Protocol to reduce their greenhouse-gas emissions will be far less costly to achieve if they can be met at least in part through investment in cheap abatement options available in developing countries, as is permitted under the Protocol’s Clean Development Mechanism. Developing-country NGOs and others involved in the policy debate on the CDM have frequently raised concerns, however, about the so-called “low-hanging fruit” problem. The standard characterization of this problem is that if developing countries allow their cheap abatement options to be used now, they may find themselves worse off in future when they take on emissions-reduction commitments of their own, because only expensive abatement options will remain. We show that under plausible CDM-market imperfections a low-hanging fruit problem may indeed arise, but that the standard characterization of the problem is incorrect. We also present a potential solution, based on mandating a “virtual” option clause in CDM-investment contracts.