In
my last post[1], I
noted that I, personally, am a climate change sceptic[2].
I also believe that we should not take any major action to mitigate the feared
implications of climate change unless our major trading partner, the U.S, does
likewise. However, I then went on to argue that if we must do something, then a
carbon tax should not be rejected out of hand because it provides more
opportunity for the market (businesses and consumers) to freely make economic
choices than government regulation. For example, if the tax is high enough,
businesses will seek alternative ways to produce. I also, mentioned in passing
that a cap-and-trade system as instituted by Ontario and Quebec is, in
principle, better than carbon taxes as a means to harness the ability of the
market to fight carbon and other forms of pollution. While seeking the same
objectives as a carbon tax, it achieves its goals at a lower overall cost
for society. From a stewardship perspective that is important, since we
don’t want to waste any of our God-given resources. I will expand on that in
this post. However, I will first add a bit to what I said about regulation in
the last post.
Some regulation will remain necessary.
In the past, I noted, regulation
(command-and-control) was the main tool of environmental policy. Government
bureaucrats specify what companies and consumers can and cannot do. Regulation, is costly and
enforcement is frequently inadequate. Past regulation has frequently been too
precise or with too short a compliance deadline, so that flexibility to
implement the latest, best technology is reduced. I recognize, that, in
practice, carbon taxes and cap-and-trade may also be implemented with a host of
regulations and exemptions and, therefore, market choice and efficiency may be
reduced. We should seek to reduce such over-regulation while exemptions might
be better attained through other ways which do not affect the favourable
incentives intended by these two policies.
Moreover,
government regulation will have to remain a significant part of environmental
policy. For the most toxic pollutants, for example, outright bans are the only
possibility. Bans may also be required in particularly sensitive areas. The
Chinese government, for example, banned all tree cutting in the flood-prone
Yangtze basin because”trees standing are worth three times as much as trees
cut” because of the flood control service provided by the forests.[3] In other cases, such as
mandatory minimum efficiency standards for cars or appliances or some pollutant
emissions, simple regulation may prove most effective. As much as possible,
such regulations should be restricted to specifying the result (the limits
desired) rather than mandating how that result is to be achieved so that
companies are left free to decide how best to meet these standards.
Regulation is also
necessary to specify conditions for companies to operate in particularly
environmentally sensitive areas e.g. drilling for oil and gas. Even then,
however, the market can be used to supplement the regulations by requiring
‘environmental performance bonds’ (an insurance to be bought by companies who undertake
environmentally sensitive actions such as building a pipeline through nature
reserves). The market determined price of the bond will reflect the potential
liability and force the companies to consider that cost. Moreover, in case of
actual damage, the money can be used to rehabilitate the environment and
compensate victims
Detailed government regulation is also required when the
interests of parties in the marketplace conflict. For example, in 1990,
European governments were concerned with the reduction of emission of volatile
organic compounds (VOCs) which escaped when cars were being refuelled. The
problem could be addressed either on the cars by installing a carbon cannister
that would absorb the vapour or, alternatively, by installing a vapour balancing
system on the pumps. Obviously, the oil companies and the automobile
manufacturers could not agree on the choice. The German government finally made
the decision in favour of the pump system.[4]
In any case, the need for regulation continues. Continual
review is, however, a necessity–if only to ensure the regulations do not become
obsolete. Where regulation is deemed to be necessary, we must be prepared to
devote adequate resources to establish and enforce them.
The Advantage of Cap-and-Trade
Cap-and- Trade (also referred to as
a system transferable pollution permits) has the government set a cap for
the total amount of carbon (or other pollution) emissions. Allowances or
“rights to pollute” are then divided over all the companies either by auction
or otherwise. The auctions generate revenue for the government.The key to the
overall cost saving is that these allowances may be bought and sold. A
simple[5] example, will, hopefully
make this clear. Consider the following companies who pollute different amounts
(Column 1) and differ in how much it costs them to clean up their pollutants
(Column 2):
Table 1 Cost of
Cleanup
Total per
Pollutants pollutant
(1) (2)
Company
1 6,167 $100
Company
2 5,500 125
Company
3 25,000 150
Company
4 50,000
225
Company
5 30,000
300
116,667
Now consider the cost of
cleanup if the government mandated a cut of 10% across the board. The cost to
society of every company reducing their pollutants by 10% would be $2,530,000.
Table 2 Cost of
Cleanup 10 % Cost
Total per pollutants
of
Pollutants pollutant Cleaned up
Cleanup
(1) (2) (3) (4)
(2) x (3)
Company
1 6,167 $100 617 $ 61,670
Company
2 5,500 125 550 68,750
Company
3 25,000
150 2,500 375,000
Company
4 50,000
225 5,000 1,125,000
Company
5 30,000
300 3,000 900,000
116,667 11,667 $2,530,000
Now suppose we have a cap-and-trade scheme that would
allow the rights to pollute to be traded. Let’s assume a market price for
pollutants at $130[6].
At that price, it would pay Companies 1 and 2 to clean up all their pollutants
since they would be able to sell their right to pollute. On the other hand, it
would pay the other three companies to buy these rights instead of cleaning up
since their cost to clean-up are higher than this market price.
Table
3 Cost of
Cleanup amount Cost
Total per pollutants
of
Pollutants pollutant Cleaned up
Cleanup
(1) (2) (3) (4)
(2) x (3)
Company
1 6,167 $100
6,167 $ 616,700
Company
2 5,500 125
5,500 687,500
Company
3 25,000
150 0 0
Company
4 50,000
225 0 0
Company
5 30,000
300 .
0 0 .
116,667 11,667 $1,304,200
By having only those companies
clean up that can do so at the lowest cost, 10% of pollutants can be cleaned up
for $1,304,200 rather than $2,530,000.
The same amount of pollution is cleaned up at a much lower cost under
cap-an-trade than by government mandate a cut across the board. That’s the case
for cap-and-trade!
Not only does every
company have a financial incentive to reduce its pollution, with tradeable
rights, the market will also ensure that the overall cost to society of
pollution reduction will be as low as possible. Companies with more difficult
problems can, in the first instance, buy up the available rights to pollute. As
these rights become more expensive, the incentive to find technological
solutions will increase. While the government enforces the overall permitted
amounts, the market decides the most cost-effective way to reduce. In fact, the
market price of the traded permits also serves as price signal. The higher the
market price for the permit, the more incentive there is for innovators to
devise new remedial technology or processes.
A final benefit of the system is that environmentalists or governments
can speed up the clean-up process by themselves getting together and
purchasing--and not using--the pollution rights. In Cleveland, for example, a
group called INHALE sprung up to buy and bid up the price of sulphur-dioxide
credits so that U.S. utilities would be forced to clean up their own emissions.[7] Such action reduces
pollution immediately and, by raising the price of rights, increases the
incentive for others to reduce pollution.
Of course, the effectiveness of tradeable quotas will
depend on the extent of the permitted emission amounts—the cap. Any cap will be
an arbitrary number but can be reduced over time to get the desired result
while generating the least amount of disruption (e.g. in terms of employment).
As such, this policy alternative (just like green taxes), is consistent with
our conditional preference for the market. Since climate change is a global issue, it
would seem reasonable that these allowances be traded over wide regions as has
been done for carbon in a linked market by Ontario, Quebec and California. If
you believe in the need to reduce carbon, it doesn’t matter where this
reduction takes place. The problem is, however, to what extent these markets
are actually harmonized e.g. are the caps equally burdensome etc? Only time
will tell whether the implementation of this system will achieve the desired
effect. In any case, cap-and-trade is, in principle, a useful policy tool in
the fight against climate change—if you believe in the need to do something about
it.
[2]
That skepticism was reinforced by a recent post
I read by Matt Ridley, “The Climate Wars’ Damage to Science”, https://quadrant.org.au/magazine/2015/06/climate-wars-done-science/
[3] Lester R. Brown, Plan B: Rescuing a Planet
under Stress and a Civilization in Trouble, W.W. Norton & Co. Ltd., New
York, 2003. p.209.
[4]
Lévêque and Nadaï, in Henk
Folmer, H. Landis Gable and Hans Opschoor, editors; Principles of Environmental and Resource
Economics: A Guide for Students and Decision-Makers, Edward Elgar, Aldershot, UK & Brookfield,
US., 1995,p.317
[5]
And, admittedly, simplistic.
[6]
This market would come to equilibrium at a price between $126 and $149
[7]
Robert Sheppard, “How much am
I bid for a pair of carbon-dioxide credits?” The Globe and Mail, Jan 17, 1998.
