Felix Salmon

Larry

Summers has problems with a cap-and-trade approach to reducing carbon emissions.

He leaves us dangling with a promise that next month (his FT column comes out

monthly) he will reveal a better alternative. But without knowing what that

better alternative is, it’s worth looking at his reasons for mistrusting a cap-and-trade

approach.

1. A cap-and-trade approach, while binding in theory, might not be in practice.

   This is a danger, but I’m not too worried about it. Summers uses the example

   of the Maastricht Treaty, which broke down when it became obvious that some

   countries wouldn’t meet the targets. But in the case of Maastricht, there

   wasn’t a strong constituency which would lose a lot of money if the targets

   were allowed to lapse. A cap-and-trade system creates a whole infrastructure

   of exchanges and traders who are financially invested in those caps –

   not to mention the polluters who spend a lot of money on buying emissions

   rights, or who make a lot of money by cutting their emissions and selling

   their rights. Once that infrastructure is in place, there will be huge pressure

   to make sure the caps stay in place, not only from environmentally-aware voters,

   but also from large companies.

2. "The limited impact of Kyoto is evinced by the fact that carbon

   permits are now selling in the range of a negligible one euro a ton."

   It might be true that Kyoto has had a limited impact: this is reason to expand

   it. But it’s emphatically not the case that low carbon prices are

   a sign that Kyoto isn’t working. To the contrary, low carbon prices are what

   you would expect if carbon caps worked very well, and people found cheap and

   effective ways to reduce their carbon emissions. The reason that carbon prices

   are low in Europe today is because a lot of coal-fired plants went offline

   much more quickly than people had expected. That’s good news. Carbon permits

   further in the future are much more expensive. Things are generally working

   as one would hope and expect, and what errors have been made in the past,

   surrounding estimates of existing pollution levels, can be fixed in the future.

3. "Carbon markets are invitations to engage in pork-barrel corporate

   subsidy politics on a massive scale."

   A common criticism, but a false one. If I’m a big polluter and I get allocated

   a hugely valuable store of emission rights, how am I supposed to be able to

   monetize those rights? The only way to do so is by stopping polluting –

   basically, I’d have to close down my plant. What Summers fails to realize

   here is that the assets that get handed out under a cap-and-trade scheme are

   offset by even bigger liabilities: no one gets more emission rights than they

   actually pollute. Under cap-and-trade, everybody starts off "short",

   even if the rights are allocated rather than auctioned.

4. "While in principle emission permits could be auctioned, in practice

   they are always allocated administratively."

   We’re in the very, very early days of cap-and-trade: this kind of generalization

   is impossible to make with a straight face.

5. "The clean development mechanism has resulted in substantial payments

   for emissions reductions that would have occurred anyway or could have been

   achieved at negligible cost. There is even reason to think that certain industrial

   gas emissions may have been increased so that credit could be claimed for

   their abatement."

   I haven’t heard the latter claim: I’d like to see Summers’s evidence for it.

   But certainly a cap-and-trade scheme can and should be refined in order to

   give credits to early adopters, and to make it hard to game the system. On

   the other hand, the whole point of the cap-and-trade scheme is that

   it incentivizes people to do low-cost emissions reductions. If it achieves

   that, then so much the better.

6. "The most serious problem with the Kyoto framework is that it is

   unlikely to generate substantial changes in developing country policies…

   The truth about climate change policy is that developing countries are where

   most of the future action has to be."

   What’s certain is that developing countries won’t do anything unless and until

   the developed countries take the lead on this issue. What’s more, a good global

   system of offsets, where developed-country polluters can claim credit for

   emissions reductions in the developing world, would solve some if not all

   of these problems. In any case, unless Summers can reveal next month a scheme

   which the developing world is sure to sign on to (probability: 0%), it’s surely

   a good idea to get moving now where at least it’s possible to make a start

   on these issues.

I do look forward to what Summers proposes next month, although it can’t be

a good sign that he admits at the outset that emissions reductions will be lower

under his scheme, at least in the short term, than they would be under a cap-and-trade

system. As a general rule, I think it’s a good idea to do as much as we can,

as soon as we can. "It won’t solve everything, therefore we shouldn’t do

anything" is just a silly argument.

Greg

Mankiw, one of the leading proponents of a carbon tax, claims to be agnostic

about the carbon tax vs cap-and-trade debate,

at least if carbon credits under a cap-and-trade system were auctioned rather

than freely allocated:

Of course, selling emission allowances under a cap-and-trade system makes

the system equivalent to a comparably-sized Pigovian tax.

Mankiw is surely wrong here: the "of course" guarantees that, even

if he’s right on substance. It’s conceivable that an auction-based cap-and-trade

system might end up being equivalent to a comparably-sized carbon tax. But it’s

hard to know that ex ante, and it’s certainly not obvious.

The biggest difference, of course, is that even if government revenues are

the same under both systems, total carbon emissions are not. In a cap-and-trade

system, emissions are capped. That’s the whole point. (And it’s why "safety

valves" are a very bad idea.) There’s no cap on emissions under a carbon-tax

system.

Also worth reading, in Mankiw’s comments, a case for why a cap-and-trade system

actually involves less bureaucracy and overhead than a carbon tax:

You’ve yet to establish that a system that requires bureaurcracy, invoicing,

billing, and payment processing every year (and all run by the federal government)

is as cheap as a system that only requires costs when caps are transacted

or people are looking for caps to purchase (whether you choose the initial

purchase or not), all run by the private sector.

I also happen to suspect that you could make a case for lower enforcement

costs under caps too (if random checks are feasible) versus a system where

you must measure *every single participant* to bill them correctly.