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The Economist Magazine on Carbon Policy in the Year Ahead

December 29th, 2008 . by economistmom

The Economist’s “The World in 2009″ special issue is really great reading, and in this year’s issue they include a special section on the environment.  Deputy editor Emma Duncan leads off the section with “Wonderful, wonderful Copenhagen?”–suggesting that carbon policy is going to be a really “hot topic” (my pun intended) in the year ahead, especially here in America:

The most important year for climate change since 2001, when the Kyoto protocol (which set targets for cutting carbon-dioxide emissions) was agreed, will be 2009. The first period of the protocol runs out in 2012. The deal to replace it is supposed to be done at the United Nations’ Climate Change conference in Copenhagen, which starts on November 30th 2009 and is due to end on December 11th. No deal means that mankind gives up on trying to save the planet.

The accord needs to be a substantial one, not just a face-saving agreement to declare that the issue must be tackled. The rich world (especially America) needs to commit itself to legally enforceable carbon-emissions reductions for the second period of Kyoto, from 2012 to 2016 and beyond. The big emitters from the developing world, such as China, need to commit themselves to something substantive—not economy-wide emissions-reductions, but, for instance, carbon-intensity targets (cuts in carbon emissions per unit of GDP) or measures directed at the power sector in particular…

What happens in Washington is most important. Progress on climate change is much likelier under the new administration than the old, for the new one is committed to introducing mandatory federal carbon-emissions cuts through a cap-and-trade scheme of the sort that operates in Europe. What is not clear, though, are the answers to the crucial subsidiary questions. Where do the cuts come from? And how big will they be?

The amount of political capital the new president is prepared to spend on climate change will determine the answers to those questions. Plenty will be needed to overcome opposition from organised labour, which fears possible job losses resulting from the higher costs that carbon constraints are bound to impose, and from dirty industries, such as aluminium, cement, oil and carmaking, which fear the impact on profitability. The administration is likely to reach for “border adjustments” (tariffs on carbon-intensive goods from countries that America thinks are not doing enough to cut emissions) to help overcome objections from those quarters. It may disappoint greens by going for a system that includes a cap on the carbon price, and by setting the cap on emissions higher than environmentalists would like. And even with those compromises, getting legislation through Congress in time for Copenhagen will be exceedingly difficult.

And The Economist’s energy and environment correspondent, Edward McBride, continues to worry about the inevitable political opposition that carbon policy will face, in his article “Fighting for the planet” (subtitle “So much to argue about in green politics”):

The giddy price of oil subsumed most talk of the environment in 2008; in 2009 the price of carbon will be the most pressing question. In America, the new president has pledged to cut emissions by instituting a cap-and-trade scheme: expect a drawn-out battle in Congress…

As with free-trade deals, the proliferation of regional and local carbon-trading schemes is likely both to spur efforts to reach a global accord and to complicate them. In America, ten north-eastern states have grouped together to form the Regional Greenhouse Gas Initiative [link added], a cap-and-trade scheme among utilities that starts running on January 1st. Opponents of emissions-trading will hold up every glitch as an example of how misguided the whole concept is; proponents will insist it proves emissions-trading is viable, whatever its flaws.

Western states plan another, more ambitious programme, while Midwestern states are working on a third. To make matters even more complicated, several Canadian provinces plan to participate in the various American initiatives, in protest at the relative modesty of Canada’s own national scheme. Australia and New Zealand will try to link up their respective systems. And there will be a row, complete with legal battles, over the EU’s plan to levy a carbon tax on flights to or from Europe. As a negotiating stance, the regions and countries with more stringent policies will insist that national and global arrangements must not pander to the lowest common denominator. But they will also be quick to scale back their green ambitions if efforts to set up broader trading schemes founder.

All this uncertainty will not be good for the carbon markets. Prices will be volatile, providing more ammunition to those who dislike the idea of emissions-trading…

Which leads me to take notice of this point in Dan Rosenblum’s comment to yesterday’s post on gasoline prices:

…you correctly note in your post that a high price and certainty are necessary. A cap-and-trade program, unlike a carbon tax, would result in serious price volatility. The result? Energy users would not have the price signal they need to encourage investment in energy efficiency and less carbon intensive fuels. For a more detailed comparison of carbon taxes and cap-and-trade, see the Carbon Tax Center web site.

Economists (who naturally have a bad tendency to abstract from reality) tend to view a carbon tax policy as basically equivalent to a permits/cap-and-trade carbon policy where the tax rate happens to be set at the market-clearing price that would result at the quantity of permits provided, and where government receives the full market value of those rights to emit carbon (all of the revenue from the tax).  But of course, in practice that market-clearing price would be constantly moving around under a permits policy that would set the quantity, not the price.  A carbon tax policy, on the other hand, sets the price, but results in uncertainty about the quantity (the end result in terms of carbon dioxide emissions).  For a market-based strategy that will undoubtedly interact with the rest of the economy and its dynamics, however, as well as one dependent on continued political support (in these difficult, recessionary times), it strikes me that it’s probably more important to establish certainty about prices (economic impact) much more than certainty about quantities (environmental impact).

One Response to “The Economist Magazine on Carbon Policy in the Year Ahead”

  1. comment number 1 by: dave.s.

    It’s been my impression that one of the worst aspects of cap-and-trade is that there will be a lot of resources spent on developing the system and running it; that a carbon tax will be far cheaper to run.
    Volcker said at one point that we were spending far too much on our financial industry (then running about four per cent of GNP), that historical levels had been between one and two percent. At this point he’s looking pretty good - do you have any idea what the cost comparison would be?