Cap and Trade Derails Climate Ethics, the Motive Force of Carbon Mitigation – Part 2

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In the first part of this post, I outlined how the components of cap and trade don’t work together to cut emissions.

2. Cap and Trade’s Perverse Ethics Threaten Climate Policy Effectiveness

The role of ethics in economic policy, and in climate change policy in particular, is misunderstood or underrated. Ethics as an animating principle of government or civic action is not simply a matter of maintaining or broadcasting ethical rectitude by individuals or organizations or avoiding certain lapses or illegalities. Sometimes viewed as optional or of limited use, ethics is often brought into discussions after the fact, explicitly to judge the behavior of individuals or organizations or implicitly to achieve higher personal status. However ethics can be more broadly understood as one of a continuum of means by which value, negative and positive, is assigned to things, people, actions, and ideas. I am using “ethics” as the inclusive term for “ethical codes, values, and morals”.

The choice in ethics on a community or national scale is not only between good and bad or in resolving an unusual and challenging conundrum as is often brought to the attention of professional ethicists, but in the alignment of priorities between what gets more attention and resources and what gets less. The value of climate protection and clean energy is for most people and governments still a somewhat lower priority than, for instance, national defense, as is reflected in their respective budgets in most countries. While some feel that calculated costs and benefits should always determine political and economic decisions, how one accounts for costs and benefits is a matter of a series of ethical choices. Furthermore political and cultural leaders and active social movements can via their ethical commitments and leadership change the priorities of a nation and thereby alter the budgeting, effort and time priority assigned to each set of activities.

Climate Ethics Is Not Optional

In an earlier post, I have compared the fundamental task in climate policy to overcoming an addiction. In an addiction, impulses to use a harmful substance overwhelm the rational thinking and ethical parts of the individual; for addicts, rationality becomes an instrument to search for the supplies of the addictive substance and cover up its consequences, including lying to others and to yourself. To overcome an addiction, most addicts need to install an “external conscience” in the form of a community of people who monitor them and encourage them for years or for the rest of their lives.

Addiction is about putting short-term gain ahead of long-term viability; similarly a society such as ours that depends on fossil fuels or the overexploitation of the soil and forests is placing immediate satisfactions ahead of long-term sustainability. Over the past two hundred years economic growth and activity has been intimately linked with the use of energy-using devices which worldwide depend for 85% of their power on fossil fuels; one could almost define economic development in the last century as the increased use of fossil, hydroelectric and nuclear energy to do work that would in the past have been done by human or draught animal muscle power.  Increasing convenience, the shortening of the distance between a wish and its fulfillment enabled by cheap energy, has become a hallmark of individual and social wealth. To enable us to overcome the pull of cheap fossil energy we need not only to listen to speeches about how bad it is but to have an effective policy framework that guides us to reduce our use of fossil fuels and increase the supply of clean energy.

In chemistry many reactions have to go over an energy "hill" called the "energy of activation" to occur. This "hill" is lowered by the presence of one or more catalysts which lower the amount of energy required for the reaction to occur. Government’s role can be viewed as a catalyst for certain economic transactions that don’t happen spontaneously but are socially or economically desirable. (Image:

A metaphor from chemistry might also help illuminate the challenge facing us. Some reactions in chemistry happen pretty much spontaneously because there is no or very little of an energetic “hill” or energy of activation to surmount in order for the reaction to proceed. Other reactions, many of them in biological systems, require the presence of one or more catalysts or enzymes (biological catalysts) which decrease or supply the energy of activation of the reaction. The input of energy, like the heat and chemical transformations of a fire, is a catalyst for many reactions including those involved in cooking. Just as spaghetti doesn’t cook itself without boiling water, it is clear that we, as participants in economic systems, are not spontaneously protecting the Holocene climate. Some hold out the hope or subscribe to the philosophy that the only good or “natural” economic activities are those that happen “uncatalyzed” by government or the exertion of ethical will. This philosophy tends to naturalize what already has been achieved with or without government and has no account for how things change or how new challenges can be met:  it is a “just-so” story.

While it would be preferable if good things would happen only “by themselves”, without catalysts, we have discovered that this cannot be counted on to induce us to control emissions of greenhouse gases:  too many of our satisfactions have come to depend on the use of fossil fuels and we don’t experience the negative consequences directly. Our economies that run largely on narrow self-interest alone will not institute the technological changes necessary spontaneously, because of their costs or the diversions of the other interests that all of us have.

Good climate policy supplies the “energy of activation” or the catalysts for those “reactions” to take place, to enable people to make the decisions they need to make to protect the climate. The basis and power of that policy comes from an ethical commitment of leaders, citizens, and activists to tip the scales in favor of carbon mitigation, and to a lesser degree efforts at adaptation to climate change. In some areas, it may take a mere informational “nudge”, in other areas, it may take a decade or two of costly effort to supply this “energy of activation” yet the costs of inaction are in this case far greater.

Government is the only institution with the potential to enact these ethical commitments on an economy-wide scale and that can level the playing field. Shaping markets is an important part of government’s activities, which is not often welcomed by participants in those markets. This requires the ability to marshal as much support as possible for these tasks from the citizens and business interests as well as the ability to anticipate resistance to these changes from the same groups. There is both economic pain and reward involved both of which should not be ignored.

An embrace of government’s role is not the embrace of a positive utopia or single guiding principle for social and economic life but simply an acknowledgement of a diverse and complex human nature. There are many who struggle against what seems obvious or commonplace in the observation that government plays a necessary but distinct role in the economy, especially in times of crisis or rapid change. There are still many believers in the self-sufficiency of markets which supposes that government’s catalyzing of economic activity is either unnecessary, harmful, or should remain invisible for ideological reasons. Some insist on a largely painless transition to a clean energy future: this is highly unlikely and requires waiting for technological breakthroughs that may not occur in time. Others believe that their policy instrument (cap and trade) will scour the world for all “least cost” opportunities to reduce emissions before any economic pain is inflicted at home. Still others hold out the prospect of a relatively painless status quo, and this seductive notion animates those who deny or minimize climate change.

While we are, in an age of cynicism about government and humanity in general, unused to thinking about government as the instrument of popular morality, most halfway legitimate governments express through the passage of laws and their enforcement the values of their respective communities; without a shared sense of ethical justification for laws, a government quickly loses its legitimacy. By contrast, unregulated markets have tended to promote at best a narrowly utilitarian morality that has little concern beyond the horizon of the next few years, the next few months or the end of the current transaction. Markets encourage most often those transactions that happen pretty much spontaneously, based on a narrow form of self interest as defined by traditional corporate accounting. Governments backed by substantial ethical justification and assent from civil society are the only institutions that can in large number of transactions tip the scales in favor of solutions that address medium- and long-term issues that do not have a major impact on this year’s balance sheet.

Thus returning to the formulation in the title, ethics (duty-bound commitments to the future and to the vulnerable on the planet) are the locomotive of climate action and government action and policy aligned with these commitments are the prime vehicle for their realization. Acts of individual and corporate virtue and creativity will be an integral parts of moving us forward but are no substitute for widely held ethical commitment to these goals that include the highest ranks of government.

Cap and Trade’s Ethical Trap

The “dressing up” of markets, especially trading-based markets, as agents of morality in the last three decades has come at a time that is unfortunate for the future of our favorable climate. Markets have been held up as “better than” government and government’s role. Meanwhile, if viewed dispassionately and without pro- or con- ideology, unregulated markets use resources profligately and without regard for its impacts in search of short-term favorable return on investment. Carbon dioxide emissions do not substantially threaten the economic utility (subjective assessment of value) of the major polluters or many of their customers, in their current perceptions. These factual observations should not be attributable to one political wing or another. Having to re-establish or establish for the first time government’s legitimacy in these matters just adds another political challenge to the process of dealing with climate change

Cap and trade is an effort to clothe the administrative and ethical role of government in the supposed ethics and/or efficiency of markets, in this case, the carbon permit market. The twisted result is a huge policy blunder and is not as good as the more straightforward carbon tax/dumping fee or direct regulations, which acknowledge governments’ leadership role in these matters. A shorthand way to look at emissions trading is that an artificial permit market is supposed to “emit” the carbon price signal to the real market for carbon emissions reductions. The substantial effort involved in rerouting the intentions of government leaders via carbon markets ends up obscuring or voluntarily hamstringing the role of government. It is unfortunate that some of these truths are being pointed out by politicians and others who want no climate policy whatsoever; this does not make their observations about cap and trade completely false.

In the 1990’s, when cap and trade was formulated, a generalization and expansion of the role of derivative trading in the economy was considered to be commonsensical and a sign of economic health. The perspective looks different now, after we have experience a monumental financial collapse which was enabled by the meteoric expansion of derivative trading during the last two decades. The designers and advocates of cap and trade make the derivative trading component, the insertion of a vast market of middlemen, seem a trivial addition to the concept of a carbon price, which is represented most simply as a carbon tax or fee. However as we have seen this trading market substantially changes the determination of a carbon price and diminishes its usefulness as a tool to spur investments in real technologies.

In proposing cap and trade systems as the climate policy of choice, governments also try to insulate themselves from taking direct responsibility for carbon mitigation. Once a cap has been set, the work and responsibility of government is obscured by the activities and vacillations of the carbon market which is then “responsible” for the carbon price that is generated. Ultimately this creates a situation where, in the end, no one is directly responsible for climate protection as government can point to the permit market as being at fault for lagging implementation of carbon emissions reduction. Some may view this as positive, perhaps insulating climate policy from the vicissitudes of politics, but in the end this means that the insulated climate policy will be ineffectual, non-transparent, and corruptible by system stakeholders who are interested in maintaining a fossil fueled status quo. Immediately or in the near future this failure has a high probability of becoming a political liability.

The Pricing of Carbon as an Ethical Enterprise

In the “prospectus” for cap and trade is the claim that beyond setting the cap, the government is allowing markets to set the price of carbon. Somehow this is supposed to make the price of carbon seem more “real” and be more “efficient” to market actors. However, what happens, viewed from the point of view of authorship or responsibility, is that government issues a certain number of permits from which it might be expected that a certain average price will emerge yet afterwards allows both auctions and trading to ultimately determine the carbon price;  calculations of economic impacts of the policy will always project prices which are the operative economic units, not numbers of permits. The interplay of what market actors think a permit is worth at one point of time or another in bidding or trading, has not that much to do with the cost of mitigation of carbon emissions or the damage those emissions cause, i.e. their fundamental value. In 2008/2009 carbon prices have doubled and halved in value within the span of a year depending on factors such as the cost of oil and the general strength of the economy; neither of these factors have much to do with pressing on with decarbonizing the economy.

Put another way, the biosphere and atmosphere “don’t care” about the opinions of various permit buyers, the price of oil or economic downturns. Pricing carbon is about impressing the impacts of carbon emissions upon the valuation processes of all economic actors, not the other way around. (Furthermore this impressing of the impacts is supposed to occur within and an investment [longer] and not a trading [shorter] timeframe, so there is a fundamental mismatch between the instrument and the task.) We are already at atmospheric concentrations of 387 ppm carbon dioxide, past what most scientists believe to be the optimal set point for carbon concentration in the atmosphere. The real cost then of additional emissions is at this point in time close to astronomical because all emissions now contribute to irreversible warming. While an astronomical price of carbon is not realistic, to sever the ties of that price to the scientific reality by allowing the interplay of market participants to determine the price is a distraction that serves no purpose according the manifest large-scale goals of any carbon mitigation policy. Furthermore this is again, as above, a case of “diffusion of responsibility”, where introducing more actors into a situation creates the situation where each actor feels less compelled by ethical standards to take responsibility for the situation.

Instead governments need to take responsibility for their (new) role as protectors of the atmosphere and the climate, one part of which (and this is not the only part) is to set a price for carbon that has a real impact on markets and leads nations and the world to meet emissions targets. The setting of this price involves calculations of what it will cost and how these costs will be paid for and their effects mitigated upon the most vulnerable parts of the population. To whom political leaders will listen most and which concerns will trump others is part of the ethical decision making involved. These decisions will not necessarily be perfect but will start a process by which they will enter a dialogue with their constituents and stakeholders where actions are easily understood in terms of their costs and benefits. Cap and trade, with its focus on trading rather than investing, surrounds political decisionmakers with groups of people, who are for the most part not particularly relevant to the process of cutting carbon emissions.

Recognition and Respect for Carbon Investment Stakeholders

Stakeholders other than government and scientists are important to include in carbon pricing decisions. These stakeholders should include the industrial groups, consumers and lenders that are affected by the carbon price, not third-parties with interests in taking advantage of derivative trading markets. Finance is important as a spur to long-term investment but the magnification of its trading component in the cap and trade instrument is the injection of an irrelevant foreign element into the carbon pricing process.

By setting the cap and letting the market “decide” government and regulators are disengaging from the process of determining costs even though, at this point in history, government sponsored engineering studies of various climate solutions are about as accurate information as we have about what it will costs to mitigate carbon emissions. The cap and trade instrument allows climate activists and government to occupy the ethically suspect role of the dilettante that want to keep his or her hands “clean” of discussions about actual monetary amounts. To remain in a position that “floats above” the process of discussing money is at this point in time ethically suspect.

The cap and trade instrument is also fundamentally disrespectful of those who will be making the decisions to cut carbon emissions. The variable carbon price without predictability (at least as a reasonable approximation over a 5 year period) does not give investment decision makers adequate tools to assess which investments they should make. Instead, the variable “wild card” carbon price that results from cap and trade, pushes upon them a frightening responsibility to make decisions under increased uncertainty. They are supposed to do “something” or pay “some money” for permits over a period of years but it is not known how much. The politicians and activists prefer the false moral certainty of the cap which pushes both discussions of money and actual decisions to cut emissions to the “polluters”. Why not make this job , the most important in the whole policy framework, as easy as possible?

I have no illusions that debating over amounts of money will not be loud and obstreperous. However the fight should be carried out as openly and transparently as possible so as many stakeholders as possible can see and understand the results. By contrast, the setting of a cap only has indirect meaning and impact on constituents and stakeholders, which then does not allow an open and honest dialogue and debate about the costs of climate mitigation. Perhaps in the 1990’s, leaders shied away from entering this dialogue because they have not been prepared to do so. Now we can assemble the tools to discuss the costs and benefits of climate action with all. In addition, in the 12 years since Kyoto, it has become more obvious to many people around the world that something is happening to the climate, so open discussion rather than the vague proclamations of intent is more of a possibility.

The Structure of Cap and Trade Defeats the Ethical Force of Climate Action

As it now stands, our short-term self-interests as people living in 2009 are not generally aligned to create a sustainable economy. In the developed world, if it were up to us, we would “party like its 1999” perhaps with a few green tokens that would declare us to be virtuous people in our own self-estimation. In the developing world, many people want to live some approximation of the lifestyle of those in the developed world with their accompanying reliance on conveniences powered by fossil fuels.

The strongest countervailing forces to these tendencies are our own observations and the observations of scientists that we have started to degrade the world by our activity and that we are concerned about the environment that we will leave future generations or force upon the less powerful or privileged parts of the world. These ethical concerns informed by science are the most consistent source of power for climate agreements and climate policy. We require a clear regime of rules, incentives and disincentives combined with leadership in the right direction that are as directly as possible connected with these sentiments and observations.

The complexity and dysfunctional nature of the cap and trade hybrid instrument does not offer a lever or “button” upon which the combined ethical force of those concerned about the future of our planet can “push” to make the instrument actually make substantial cuts in emissions. Once the cap is set, the supposedly impersonal forces of the market will determine the outcome; within the policy’s design by intention no agent is simultaneously directing the investment process and responsive to the calls for climate action. All interactions with low carbon technology and emissions cuts will be filtered through the carbon market paradigm. While this is an advantage to those who want to slow action on climate change, ostensibly the creation of a cap and trade system was to accelerate action on climate change. The policy itself is at war with the ethical justification for its existence.

The declaration of the cap, component “4″ of the cap and trade hybrid that I described earlier, also is taken by those who don’t bother with or understand the economic decision-making and technology-specific parts of policy options as a seductive ethical quasi-fait accompli. They might think: “I have subscribed to this policy that pledges this goal (with impenetrable economic explanations attached), therefore I have done my duty”. Unfortunately the devil is in the details which are difficult to delve into without some understanding of how investment decisions are made. The declaration of the cap however “tight” or not gives subscribers to the policy a sense of virtue without really seeing how the policy itself undermines or makes achievement of an ambitious cap much more difficult.

My friends who support cap and trade will point out that they call for a version of the instrument with 100% auction and tighter caps. Surely, they think, this is putting the screws even tighter on the “polluters” and sending the message via higher permit prices that investment must be made in carbon mitigation. While the “fantasy” version has yet to be enacted anywhere in the world and may very well never be enacted, the problem is that a more rigorous cap and trade system makes the job of the people who actually cut carbon emissions much more difficult than it has to be. A predictable price will be a spur to investment, while the swings of a carbon market will slow investment in carbon emissions reductions.

Carbon Taxes/Dumping Fees and Direct Regulation Are Responsive to Climate Ethics

If we contrast this with direct regulation or a carbon tax or fee, the ethical structure of the instruments become more obvious. Imposing a tax on an activity, especially framed as a Pigovian “sin” tax, means that we are penalizing that activity or asking for compensation to society for damages. In essence a carbon tax is consistent with the valuation of carbon emissions as “bad” though not criminal. Auctioning permits to emit says that carbon emissions are neither good nor bad, ie. this activity is permitted but has an indeterminate cost and a market value. Already at this level, cap and trade is “protecting” emitting carbon from moral opprobrium. Like it or not, moral concern, anxiety, anger and outrage expressed and directed wisely is going to have a determinative ongoing role in spurring climate action.

Furthermore, as we are recognizing here that relatively speaking governments have an eye to long-term outcomes to a much greater degree than market participants, the carbon tax or fee gives government actors by extension civil society a direct “say” in the accounting of damages and the remedies for those damages. While cap and trade gives governments only a very indirect instrument to influence market behavior, a carbon tax or fee allows government to put its “hand on the scale” to influence economic decision making directly. Remember that the “certainty” of the cap is illusory because of the cap’s enforcement problems; placing a “dumping fee” on emissions is a much more direct and practical expression of concern.

Both taxes/fees and cap and trade create revenue streams for government which can be directed or misdirected any number of ways. Within the policy choice between a quantity vs. a price instrument is no formula for how to direct the resulting revenue which will be determined by politics and the local economic consequences of the policy itself. However taxation at least historically is understood as a revenue stream, therefore there is greater chance for a transparent accounting and open discussion of where the money will go.

Additionally and more clearly, direct regulation is consistent with our emerging ethical evaluation of carbon emissions in that specific carbon emitting activities can be made illegal over time. For instance in the US, we could make illegal in 10 years time the use of coal to generate electricity without 95% sequestration of emissions securely. We would be making a major ethical statement about our use of coal and the pollution of our common atmosphere. This law would need to be supported by other measures to enable a transition to a clean electric generation mix but it is not difficult to achieve with the appropriate will and incentives. There are dangers of “unfunded mandates” or distortion of incentives with direct regulation, but this does not mean that any and all regulation is bad. The blanket condemnation of regulation is still a political discourse with a constituency but economic reality has shown us that we cannot do without any regulation.

Cap and trade represents something like a moral limbo for the climate action movement into which it has marched without thinking too much about giving up its moral power. Once instituted, participants in a cap and trade system would have a legal right of redress that their permitted and potentially valuable rights to pollute would be taken away from them by laws which forbid carbon emitting activities. Cap and trade thus creates a perverse ethical system. Cap and trade is more of an economic thought-experiment than a confrontation with the economic, technological and ethical realities of cutting carbon emissions.

The faith in markets around which the cap and trade instrument has been built overreached its true place in stimulating the targeted market for low-carbon and zero-carbon technologies. One of the instruments that would truly offer this “button” or “lever” is a carbon tax or fee which if demands were made that it ascend high enough, would stimulate low-carbon investments. The other instrument would be laws which with reasonable time frames and imposed-cost calculation, circumscribed or forbade particular high-emissions activities that destabilize the climate.

Image source: bob august

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