I was reading Paul Krugman's column the other day and was dismayed by his argument. According to the Nobel Prize-winning economist and New York Times columnist, a half-ass, half-hearted measure on curbing carbon emissions is better than doing nothing, but I'm unconvinced. As written in The Washington Post:
On paper, the Waxman-Markey bill puts a cost on carbon dioxide by imposing a ceiling, or cap, on greenhouse gas emissions and then setting up a market for regulated industries -- such as the electric power sector -- to buy and sell allowances to pollute under that cap. As the cap is reduced each year, market participants will exchange allowances in a complex auction market.
If you liked what credit default swaps did to our economy, you're going to love cap-and-trade. Just read Title VIII of the bill, which lets investment banks, hedge funds and other speculators participate in the cap-and-trade market. They don't have emissions to cut; they have commissions to make.
The real hidden catch of the cap-and-trade system, though, is that it will require consumers to pay twice: first for emission allowances and then for the construction of new low- and zero-carbon power plants.
That doesn't sound very good, and the bad news gets progressively worse.
Contrary to assurances from the bill's sponsors that utility customers wouldn't have to pay these costs for the first decade, some coal-dependent utilities would be forced to purchase more than half of their allowances when the program is scheduled to begin in 2012. Would these allowances reduce our greenhouse gas emissions? No; that would come when consumers footed a second bill - for the cost of their utilities either to retrofit coal and gas plants to capture carbon - something that cannot be done today on a commercial scale - or to shut them down and build non-carbon-producing nuclear plants and wind farms instead.
Read the rest of the piece for more information on why this is bad for consumers. Krugman, in dismissing critics of cap-and-trade, writes:
Well, Al Gore has praised the bill, and plans to organize a grass-roots campaign on its behalf. A number of environmental organizations, ranging from the League of Conservation Voters to the Environmental Defense Fund, have also come out in strong support.
But Greenpeace has declared that it "cannot support this bill in its current state." And some influential environmental figures - most notably James Hansen, the NASA scientist who first drew the public's attention to global warming - oppose the whole idea of cap and trade, arguing for a carbon tax instead.
I'm with Mr. Gore. The legislation now on the table isn't the bill we'd ideally want, but it's the bill we can get - and it's vastly better than no bill at all.
One objection - the claim that carbon taxes are better than cap and trade - is, in my view, just wrong. In principle, emission taxes and tradable emission permits are equally effective at limiting pollution. In practice, cap and trade has some major advantages, especially for achieving effective international cooperation.
Not to put too fine a point on it, think about how hard it would be to verify whether China was really implementing a promise to tax carbon emissions, as opposed to letting factory owners with the right connections off the hook. By contrast, it would be fairly easy to determine whether China was holding its total emissions below agreed-upon levels.
The more serious objection to Waxman-Markey is that it sets up a system under which many polluters wouldn't have to pay for the right to emit greenhouse gases - they'd get their permits free. In particular, in the first years of the program's operation more than a third of the allocation of emission permits would be handed over at no charge to the power industry.
Now, these handouts wouldn't undermine the policy's effectiveness. Even when polluters get free permits, they still have an incentive to reduce their emissions, so that they can sell their excess permits to someone else. That's not just theory: allowances for sulfur dioxide emissions are allocated to electric utilities free of charge, yet the cap-and-trade system for SO2 has been highly successful at controlling acid rain.
But handing out emission permits does, in effect, transfer wealth from taxpayers to industry. So if you had your heart set on a clean program, without major political payoffs, Waxman-Markey is a disappointment.
Still, the bill represents major action to limit climate change. As the Center for American Progress has pointed out, by 2020 the legislation would have the same effect on global warming as taking 500 million cars off the road. And by all accounts, this bill has a real chance of becoming law in the near future.
So opponents of the proposed legislation have to ask themselves whether they're making the perfect the enemy of the good. I think they are.
Except that cap-and-trade's stated results aren't nearly as substantive as he seems to think. I read several comments from European readers that leave me convinced the whole thing is just another bait-and-switch.
One can agree with the notion that this bill is the art of the possible. But at the same time one can be very fearful, cynical even, about its likely effect in practice. What if it fails? Is there a Plan B? And it can fail in several ways. As in Europe the "market price" for permits can collapse-a recession like the current one will do that. Or the major polluters may escape the need for any change by buying international permits from developing countries that promise to not cut down their forests-is there any need to elaborate? (The economists claim one of the biggest advantages of these schemes is that permits will be a globally tradeable commodity.) Or the bill might have other serious weaknesses by the time it gets past both houses-for example, the Australian scheme we have on the books here has so much conditionality built into it that it will never be enacted (eg. useful targets are totally conditional upon the rest of the world--including China and India-doing the same or better...). Cap and trade schemes are horrendously complex and will involve huge new bureaucracy and compliance and measurement arms. As a consequence they will also be expensive and the financial wizards who trade permits will take their slice too.
I would have to say that Paul Krugman's China argument is the weakest of all. Most China watchers expect them to take emission reduction seriously, but in their own time and terms-and who can blame them? They might not need a carbon tax or a cap-and-trade scheme at all. Afterall they have just built the world's single largest renewable energy supply -the 23GigaWatt Three Gorges Dam. But if the Americans fail to successfully implement an emissions reduction scheme, or worse, it involves blatant rorting by industry, we will be back to square one, or worse.
A carbon tax WILL have an immediate effect and will be transparent and much simpler to administer. As David Montgomery, the person who devised the theoretical basis of cap-and-trade schemes back in 1971 (as described by John Broder in The Times, Saturday), says: since the Waxman-Markey scheme ultimately acts like a carbon tax, why not just impose the tax? I think it tells us something when all the industry players and many governments are so enthusiastic about cap-and-trade. Alas, in the most important country apparently it comes down to the fact that the voters are still so immature that they cannot accept anything with the word "tax".
In principle, I would be with Paul. However, I would urge you to study carefully the European experience with cap and trade. It has not been that much of a success story. Before 2008, too many free permits were issued, with the grotesque consequence that real pollution was behind pollution permitted. Consequently, prices went down and with them incentives to invest in anti-pollution measures. The same is true right now with the slowing down of the economy.
Furthermore, lobbyists went into overdrive securing exemptions left and right, thus poking holes deep enough to slow the anti-pollution efforts down. Germany went from top anti-pollution "ideologue" to a de-facto rear guard procrastinator.
It seems that the system somehow managed to reward high polluting coal power plants to the detriment of gas powered plants. And there is the additional problem of the cap and trade favouring nuclear reactors whose externalities a cap and trade system for carbon dioxide simply does not consider.
Thus, a lot depends on the fine print on cap and trade. My faith in Washington might be irrelevant, however, I would not doubt that lobbyists on K-Street are perfectly capable to disfigure a cap and trade system to such an extent that a straightforward tax might become attractive again.
I worked for several years in the 'Strategy Department' of Suez, a (very) large power producer in Europe, and operating under the EU-ETS, the european cap-and-trade program. Several things on this:
1) Because the future value of permits, and the number that will be allocated for free in the future, is very uncertain, drawing up business plans for new power plants became a nightmare. Under different but sensible scenarios, we were obtaining extremely different return (IRRs of 1% to 23% in some cases). Thus, capand-trade made this kind of investment extremely risky, so that the required expected return asked by shareholders was much larger under the cap-and-trade program (increasing risk-return indifference curve).
2) Setting up sensible economical long-term scenarios of fuel, carbon & power prices (necessary for a power plant business plan) requires general equilibirum economical models, thus fairly large teams of, say, PhDs. This is unaffordable for smaller players.
3) Cap-and-trade is much more vulnerable to lobbying because much more complex. The devil is in the details. Retrospectively, I believe that when utilities and the EU commission negotiated the european cap-and-trade program, the utilities were much better informed (simply put they had more money and people studying this - at one point Suez alone had a departement of 25 full-time working out effects of the cap-and-trade program). They made the EU commission sign something that the commission did not understand well enough.
4) In theory, giving permits for free for new power plants in a cap-and-trade system (as in Europe) amounts to increase the variable costs (each MWh produced necessitated one permit) but decrease the investment cost (you receive tradable permits). So in effect the costs should remain the same. But what was observed in the actual spot prices was that the variables cost increased (100% of increase in carbon prices were reflected in the power price), but basically the subsidy given through the free permits was not. This can only happen because there was not enough competition in the building of new power plants. But that is extremely difficult to analyze for regulators. So the net result was that the free permits were effectively a true subsidy to the balance sheet of utilities. Gosh!
So I believe a tax is much simpler for everybody (utilities, regulators) than cap-and-trade and therefore preferrable. And I do not understand the argument presented in the article: whether China operates a tax or a cap-and-trade system is not the issue: it suffices to check ex post if the country emitted no more than its quota. If not (agreed?) fines will be applicable. But the way China limits its emission has no impact on this.
But I agree with Krugman: a real cap-and-trade is preferrable to hypothetical tax system. But I wish the US had studied the european experience more carefully to avoid mistakes made here. I am available to brief the Obama administration on this ;-)
Ordinarily I tend to agree with Professor Krugman, but on this issue he is just plain wrong. What bothers me most is his naïve insistence on the use of a phrase typical of those who don't care to make any real effort to get things done: "Don't let the perfect be the enemy of the good." The reason this is naïve is that it is based on the assumption that anyone expects or asks for perfection. No one is that foolish. Instead, we're demanding the good but being saddled with the mediocre and downright horrible. That loathsome admonition becomes an excuse for not doing anything substantive to combat crises that require bold, direct, and immediate action to resolve.
In the case of Global Warming, using a half-ass measure that benefits polluters while offering what are at best dubious numbers on reducing carbon emissions only makes things worse. While we continue to pollute, fooling ourselves into thinking we're doing something to curb the practice, emissions will continue to rise and the climate will have been altered beyond our ability to mitigate the worst consequences. In short, by putting off the problem it'll make required action that much more difficult later on.
