by: Michael Hoexter
In Part 1, I called attention to the rapid shift in general economic policy in the last 6 months. I developed an outline of two distinct economic schools, one that holds up the ideal of a self-sufficient, self-regulating market and another that sees markets as having shortcomings that require government to supplement and regulate where the market fails. The first school might be called monetarist/supply-side and the second Keynesian with varying tendencies within that school. I highlighted how each of these schools is attached to a particular worldview or set of worldviews. The conflict within economics will necessarily have impacts on climate policy.
Reliance on Carbon Pricing: Hanging Onto an Idealized View of Markets?
The Scottish inventor, James Watt, invented the steam engine, powered by coal, in the 1760's and 1770's. At that point in time, coal had already a long history as a heat source. Most accounts of the history of the industrial revolution and of modern economies downplay the importance of fossil fuels in spurring economic growth and the modern economy and focus on changes in end-use technologies. A post-carbon economy will require a revolution in our thinking about and focus on energy and how it is sourced.
Climate activists have been focused since the early 1990’s on instituting a cap and trade system that they feel, almost singlehandedly, would induce or compel economic actors to emit only up to a certain “cap” of greenhouse gas emissions. The Kyoto Protocol, ratified by 180 countries, is an attempt at an international cap and trade sysem. Both cap and trade and its near competitor, a carbon tax are “market-based” policy instruments that attempt to curb greenhouse gas emissions by assigning a price to greenhouse gases. The price will function as a signal (largely in the form of a disincentive) to market actors to change technologies and procedures to emit less carbon into the atmosphere. These policies are “market-based” because they rely on the pricing mechanism and allow market actors to decide how they reduce their emissions as opposed to more directive, so-called “command and control” regulations that tell market actors what exactly they must do. An environmentally-sensitized variation on the monetarist/free market worldview and policy orientation, the idea is that the private economic actors, mostly businesses, know best what to do if given the appropriate price signal.
Climate change concerns and a climate protection movement have emerged in the last two decades, an era of monetarist/free market dominance of economic policy and to a lesser extent the economics profession. Carbon taxes, though a tax and therefore viewed with suspicion by free market advocates, have a single “market-based” layer in introducing a carbon price into the calculations of market actors, a disincentive to which they can respond as they choose. Cap and trade systems add an additional carbon permit and offset trading market, in addition to introducing a (varying) price on carbon, so are doubly market-based. Despite these efforts made to introduce market-emulating mechanisms into environmental regulation, the political advocates of free markets are almost universally opposed to cap and trade, carbon taxes and direct regulation; they generally show themselves to be unconcerned about climate change and are more concerned about how any regulation will interfere with smooth and unhindered market functioning, which to them is the summum bonum (Latin for the highest ethical good).
Much discussion and dispute has been focused on the choice of which of the two main market-based instruments will do the heavy lifting in climate policy. The carbon tax assigns a price directly to carbon emissions and is levied directly by governments. It is relatively simple instrument, favored by many economists and some industries, but criticized by many climate activists who feel that it is insufficiently rigorous. Others have criticized a tax because it is politically unpalatable in an anti-tax era, still others because it does not in its initial designs utilize carbon trading. Despite this, two leaders in the climate protection movement, Al Gore and Jim Hansen, prefer an stringent carbon tax policy to the cap and trade systems proposed, though both have suggested that it should not represent a net increase in the overall tax burden by cutting other taxes or returning a dividend.
Carbon taxes and cap and trade can be distinguished as follows: the cap and trade system sets the amount of allowable GHG pollution and, if permits are auctioned rather than given away, the price follows from the cap; a carbon tax sets the price which would limit emissions via the amount of direct economic losses inflicted or fear thereof on economic actors. In a cap and trade systems, punitive fines and potential criminal proceedings can follow from exceeding the permitted amount of pollution. A lower cap produces fewer and therefore more expensive permits (in an auction) and a higher carbon tax inhibits emissions because of their increased expense thereby leading economic actors to lower levels of emissions.
The revenues from both permit auctions and the carbon tax can be directed any number of different ways: to offset or reduce other taxes, to be spent on carbon emissions reduction, or be returned to taxpayers in the form of a dividend. The latter idea is an effort to diminish the generally regressive income distribution effect of carbon pricing: the carbon price will, percentage-wise, through higher prices for energy and high-carbon intensity represent a higher portion of the budgets of lower income families more than upper-income ones. The latter system is called a “cap and dividend” or a carbon tax dividend. As it has been developed, the basic carbon pricing “concept” does not recommend or entail any particular use for the funds collected, therefore the diversity of proposals.
2) “Price signal will be clear” – As a result of the above, both cap and trade and carbon tax systems will probably end up relying on large “look-up tables” of engineering analyses of different technologies and use some type of carbon emissions calculator to assess the degree to which they will be able to reduce greenhouse gases. The price “signal” will not be the original means by which firms will calibrate their efforts to reduce greenhouse gases but will instead be facing a series of capital investment decisions that will yield either discrete emissions reductions “equivalents” or a range of reductions depending upon their actual usage, which would need to be measured after the fact. Therefore the market in emissions will involve a series of translations of expected emissions reductions with actual reductions that independent monitors will verify. So the price signal will be felt over a period of time and will not be necessarily clear. Probably the most effective aspect of this signal would be the perception that in the future, economic losses will be very high as rises in the carbon price are anticipated, so the price signal may be most effective as a blunt instrument of fear.
3) Politically feasible carbon price is low - Almost all observers agree that carbon pricing, whether arrived at through permit auctions or via direct taxation, will not in the first years be particularly high. Expectations put pricing in the neighborhood of $15/tonne or less; the current worldwide price in the economic downturn is around $12/tonne . At this price level, some efforts to improve efficiency or purchase offsets will be inspired but the effect on energy prices will be minimal, the equivalent of 13 cents per gallon of gasoline or less. Most affected at this price level will be energy intensive industries which if subject to the carbon price will be incentivized to pursue energy efficiency measures. However at these low price levels not much action will occur though as a society we will start to “at least go in the right direction”. More impressive to businesses and private citizens would be the future threat of increases in this carbon price within the framework of an aggressively administered and supported program. Political sentiment may change enabling more aggressive and higher carbon pricing which will boost the effectiveness of the carbon price substantially.
4) “Economic actors already have choice on the solutions market” The market paradigm is effective in the short term if market actors have a choice between two significantly different alternatives in terms of their carbon emissions that are made attractive or even tenable investments with the aid of the carbon price. Exceptions to this requirement are costless conservation measures and changes in behavior. Solutions need to be “on the market” or emerging onto the market for the price to actually effect decisions. The hope and theory in carbon pricing is that innovators will be providing these solutions that respond to demand from people and companies suffering or anticipating suffering from paying more for emissions-intensive products and energy. Demand for product innovation could be driven just as well or in addition by other mechanisms including straight energy taxes, conventional regulations, positive incentives, or government investment. In many sectors and technology areas, currently a very low or zero carbon alternative technology is either a) not yet on the market, b) requires a very high carbon price to be made competitive or c) requires the presence of technological preconditions, i.e. infrastructure, for the cleaner technology to function as an equivalent to existing polluting technologies. We see this in many elements of building the renewable electron economy and/or the Repower America plan. The carbon pricing model seems most appropriate to increasing energy and resource efficiency, the marketing of offsets, land-use changes or encouraging some behavioral changes by individuals rather than new paradigm development or infrastructure change. Energy efficiency or carbon offsets (which can be packaged in increments) allow for the incremental approach in the world of actual emissions reductions that matches the gradual increase of the carbon price.
5) “Emitters are morally responsible for climate change” - While designers of carbon pricing schemes may deny that they are attaching a moral evaluation to the amount of carbon tax or pollution permits that a polluter pays, the market based system ultimately holds individual or individual corporate actors responsible for solutions and implies that the worst polluters will suffer the consequences of their polluting ways. Eventually some of the economic pain would be spread around but would depend upon the actions or inaction of the polluters. This focus on what I have called a “particulate” or atomized set of actors, denies the integrated or systemic view of an economy which demands certain products that historically have required carbon emissions. A strong ethical case can be made that those who demand goods and services that depend on fossil resources or GHG emissions are as responsible as the actual emitters. Co-responsibility through a systemic approach might augment or in some areas replace a model that turns on pinning responsibility on polluters. Both individual responsibility and societal co-responsibility should not be viewed as mutually exclusive alternatives.
6) Carbon price will fluctuate dramatically (cap and trade) – The instability of the carbon price under cap and trade will make long-term investments difficult because there will be substantial uncertainty about the costs over time of paying for permits or reducing emissions to be able to re-sell permits. Carbon prices, because of the economic slowdown and the dramatic drops in the price of fossil energy, have sunk from $30/tonne in the summer 0f 2008 to currently around $12/tonne. This will make calculating financial benefits of various emissions-reduction investments using instruments like net present value difficult if not impossible. Additionally, on the other side of permit auctions, if the proceeds of carbon auctions under cap and trade systems are used as a revenue source or dividend, it will be an unreliable revenue source. This will also make long-term investments that depend on revenues from carbon auctions difficult.
7) Carbon pricing is, like all boosts in energy prices, regressive – As are all energy-related taxes or fees, carbon pricing is regressive, meaning that the resulting changes in prices will effect the middle class and the poor more than the rich. There are a number of suggestions about how to remedy this including returning all the resulting revenues as a flat dividend to people or to replace regressive taxes like the payroll tax with carbon taxes. The dividend idea will mute the price signal of the carbon price to some degree for the less advantaged.
8) Non-specific and frontloaded promotion of more costly solutions – One of the intentions of carbon pricing is to “level the playing field” for renewable energy and other more expensive clean energy generation systems. However, the carbon price by raising the price of fossil fuels and contributing to raising the price of almost every good in society, will only spur the development of renewable energy at a high price level if purchasing decisions are made based largely on present or near-term cost. This is the equivalent of building a large and elaborate scaffolding around a tree to reach the top of it rather than using a ladder or a “bucket truck”.
9) Unintended suppression of economic activity with poor calibration – If emissions reduction or energy efficiency technology is not ready or not affordable, there may be a net reduction in economic activity. This would reduce emissions but not as intended by cap and trade or carbon tax policy designers. There could be sector by sector systems that calibrate to a given market but this would defeat some of the intentions of a price on carbon and would increase complexity considerably. Business interests which want to do nothing about climate will use this as an excuse to try to delay or stop climate legislation.
10) Ties climate policy and activism to the downside of climate change – The theory of carbon pricing is so relentlessly focused on the downside of climate change that it is left open what positive emissions-reducing activities would be funded by revenues from either a carbon tax or cap and trade auctions; the negative, punitive effect of the price signal alone is supposed to suffice. Disincentives outweigh incentives in carbon pricing systems; carbon pricing is designed to say “stop” to polluters (us). The negativity of this policy instrument is a political liability, as popular support for taking steps to address climate change is key in designing an effective policy.
11) Assumes symmetry of opposites between problem and remedy – The mechanism of carbon pricing is structured as an economic force that is both symmetrically arrayed against and opposed to the emission of GHGs into the atmosphere. Carbon pricing is so relentlessly focused on emissions themselves that it may blind leaders and market actors to the possibility that the remedy for carbon emissions may be assymetrical with the problem itself. The solution may “reframe” the problem rather simply remain focused on the problem itself alone. For instance, related to “8” above, the remedy may be to invent new positive reasons to take action on climate and change our way of producing goods and services. While it is hoped in carbon pricing that the black box of the market will produce this new positive post-carbon society, there are reasons to believe that a more directive approach in certain areas may be necessary, especially with the tight timeframe given to us by climate scientists.