Tuesday, May 15, 2007

Carbon trading - not all that great

The Guardian reports on Blair-backed proposals for a new generation of international carbon trading schemes to help reduce greenhouse gas emissions. Even Dubya's close to getting on side on this one, apparently:
The plan would involve setting up a network of carbon trading schemes and is one of five main proposals drawn up by the Germans and British ahead of the G8 summit next month[...]
Under the new trading plans, China and India would not face binding targets; instead they would be allowed to continue their extraordinary economic growth in exchange for a commitment to establish national cap and trade schemes to cover some of their most heavily polluting industrial sectors, such as metals processing and cement manufacturing.
Companies in these sectors would be granted permits to emit carbon dioxide and other gases, in the hope they would rather reduce pollution than pay for permits. The idea is based on a scheme covering power generators and heavy industry that operates in Europe under Kyoto.
Further cap and trade schemes - this time with binding targets and penalties for non-compliance - would be set up to cover carbon pollution in developed countries, including the US and Australia, which have refused to sign up to Kyoto. These could be along national, regional or sectorial lines, officials said, with carbon credits eventually traded between different schemes using exchange rates similar to currency conversions, with the goal of placing a global price tag on pollution.

Last week's Economist also had a favourable story on carbon trading schemes, based on a recent World Bank report:
The benefit of this approach over regulation is that the businesses which can reduce their emissions at the lowest cost do the bulk of the adjustment. Perverse incentives that can often hamper environmental regulations may also be avoided.
These schemes are large, and growing. Last year, carbon-trading markets grew to $30 billion, three times bigger than the previous year. Trading was dominated by permits issued under Europe’s emissions trading scheme but a voluntary private market worth $100m has also evolved.

Funnily enough, many economists (primarily in the US) are arguing that such a Coasian rights-based approach isn't actually all that suitable for tackling global greenhouse gas emissions, largely because of the size and complexity of the market. More attention is again being paid to straight taxation on carbon dioxide and the other GHGs, in something closer to the classic Pigovian approach.

William Nordhaus of Yale University, for instance, argues in this discussion paper that the structure of costs and benefits of the climate change problem innately favour a price-based approach - a combination of non-linearities in emission reductions, costs and benefits, and remaining (and probably unavoidable) uncertainties means that trading schemes are likely to create much more undesirable volatility in carbon pricing, reducing the effectiveness of any international scheme. Nordhaus rather advocates a harmonised carbon tax, "a dynamically efficient Pigovian tax that balances the discounted social marginal costs and marginal benefits of additional emissions". Such a tax would increase real carbon prices by between two and four per cent per annum, he estimates.

Inevitably, politics rears its head here. A globally harmonised carbon tax is likely to be resisted by governments protective of their national powers - given a choice between a carbon tax and a less efficient market scheme, policy-makers may opt for the latter as there is less obvious cost to the electorate. And in general, national policy-makers are likely to be deterred by the potential costs of implementing any pricing scheme if the benefits are unlikely to be felt before the next electoral cycle – or indeed in the next generation.

Meanwhile, carbon trading has been embraced by corporates who've figured that with a little lobbying resulting in less than perfect market design, as with the early European emissions trading scheme, it can be a nice little earner without actually requiring much work to clean up their act. And now it seems the White House is putting its weight behind such schemes. If I can be excused a touch of cynicism, it doesn't exactly inspire confidence in achieving the necessary reductions, does it?

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