Cap-and-Trade: Wasting a Perfectly Good Crisis

Jeff Sachs responds to Kevin Drum’s recent criticism of the former’s embrace of a carbon tax over a cap-and-trade plan. He says, in part:

As for the lack of price predictability, the price fluctuations of the EU ETS are notorious. Emissions prices actually collapsed for Phase I permits at the end of that phase (2007), and recently emission permit prices have declined from more than 30 euros per ton in 2008 to less than 15 euros this year. Some European economists are arguing for a floor price in the EU ETS, which indeed would make it much more like a tax. I disagree with Mr. Drum that we should see the trading system as a helpful macro stabilizer and therefore like the fact that the price on carbon emissions has collapsed. We need a stable carbon price into the future to give the right incentives for a new generation of low-emissions technology development and adoption, and should use other economic instruments for cyclical policies.

I don’t really get this. The logic behind the cap-and-trade system is that we determine the level of emissions we can allow each year in order to reach our long term goal for carbon concentrations; we set a cap, which declines over time. Firms then pay for the permits they need to cover their emissions each year. When permits are expensive, firms will need to cut their emissions any way they can. This may involve changing production processes or investing in cleaner technologies, but if the price is very high (as in when the cap is very low), the dirtiest emitters may simply reduce output, which is a surefire way to reduce emissions.

But if businesses are voluntarily reducing output for macroeconomic reasons, then demand for permits will be very low, and the price of permits will fall. The market is trying to clear; permit prices decline until enough firms are interested in operating at a level consistent with the emissions cap. In a deep recession, prices can fall very far indeed.

If we were to stipulate a constant permit price or a minimum permit price, then we would, in effect, be lowering the cap. This makes no sense. Emissions in any given year are not important; it’s the cumulative effect of emissions over decades and centuries that matter. The climatic impact of lowering the cap in one year would essentially be negligible, but the macroeconomic cost could be substantial.

But if you think price stability is crucial enough to generate the above outcome, you still don’t need to adopt a carbon tax; you can just set a price floor. Or you can introduce banking, which would smooth prices over time. Rather than tear up the system under consideration, why not lobby to improve it?

Because, says Sachs, cap-and-trade is doomed to be implemented all wrong — too far downstream, with too many loopholes, and so forth. Which brings me back to my initial argument about all of this: Where is the evidence that things will be any easier or better with a carbon tax? If we’re going to completely abandon the policy that’s been in the pipeline for years now, we should have a pretty good sense that it won’t wind up having all the same problems. Sachs writes:

I still believe that a tax is the right way to go. I am not very confident about the fairness of backroom haggling over emissions rights now underway in Washington, or which has characterized the EU ETS. I think that the tax approach can be more direct and visible, and less vulnerable to unfair insider dealing.

Think? Believe? What is this?

Sachs is good enough to note that either pricing regime would be preferable to no pricing regime, which is exactly right. Given that, why not work on passing the pricing regime that is currently being considered by the Congress? I am simply boggled by how ready some folks are to toss aside the best chance we have ever had to pass a carbon pricing law. It’s clearly very hard to pass a pricing law; if it weren’t we’d already have one. Given how hard it is, why sabotage this excellent opportunity?

Comments

[Ferdinand E...:]

Very good article. Very valuable pedagogically, and something for everyone interested in this issue to read. I hope that the author is able to circulate it widely. Of course the bottom line is that despite the crazy belief that cap-and-trade has succeeded in Europe, it has failed just about everywhere, and recently here in Sweden we were able to enjoy one of those cap-and-trade fiascos.

For persons interested in this topic, see the work of David Victor and Ruth Greenspan Bell. Of course, Professor Victor might be wearing his high hat, and so trying to communicate with him will not work.

May 12 09:07 AM

[Trane250:]

Companies will pass on the carbon tax to utility customers. There are millions of households that heat their homes with electricity. If utility bills get too onerous, they'll install a wood or coal stove. That will pump up the CO2 emissions along with soot, mercury, SO2 and NOX.

Isn't this the same Jeffrey Sachs who pushed cold turkey capitalism on Russia? This resulted in a decade of misery for the average Russian and the rise of the new robber baron class known as the "oligarchs."

May 12 10:10 AM

[Danny Newton:]

I don't see what the difference between Cap and Trade than just paying the Mafia protection money. The protection money simply becomes a cost of doing business. The country with the least effective Mafia will do slightly better than those with a more effective Mafia. Even the Mafia has enough sense not to freeze the protection money rake off because of the average inflation being about 4.18 percent per year for the last 30 years.

Whenever I buy something, I always factor in the probability of success. There is zero assurance that Cap and Trade will fix any problem that I have and even if there was a measurable difference, the alleged benefit would flow to other people around the globe who are not paying for it. If you are going to get an alleged benefit for nothing, very little calculation is required to decide to take the benefit.

Even if there was global warming, there is no proof that there would be any negative effect on me. If I needed to keep my current climate for the next century or so, I could just move 200 miles north. The people 200 miles south of me seem not to be terribly wilted. No one has seen any sea levels rising except at locations where the ground is sinking due to the compression of sedements.

Somone should call the Bunko Squad.

May 12 01:03 PM

[LoebA:]

In response to the know-nothing response of Danny Newton, the thermal properties of ocean water are such that there is a lag time between the heating of the atmosphere, which transfers heat to the surface of the water and to the water runoff from the continents, and the heating of the full water mass of the oceans. Thus, as a matter of physics the consequences of actions taken now will not be experienced immediately. Indeed, the lagging effects will take many years.

But that doesn't mean that they won't occur, and if Mr. Newton's attitude is that anything that doesn't affect him personally and imediately is not worth considering, let me ask him if he would he feel the same if he had good reason to suspect he had swine flu and was planning to visit an elementary school. Under the test of success he has used for himself he would still go. First, visiting the school doesn't change whether he has the disease or not, so going to visit the children has no incremental cost to himself personally. Second, the dangers to others his presence might cause is something that won't be manifested until after he leaves, so under his test he can simply insulate himself from the consequences by ignoring them. That is, applying his test of success, he can pretend that his own actions do not have any consequences to others. Such a standard for human interaction relieves people who have no concern for others of any negative feelings, allowing them to go through life serving themselves without thought of the consequences. But it doesn't mean that there aren't any, only that they are ignored or rationalized away.

Mr. Newton's test of success doesn't meet the basic moral premises for civilized society, and I suggest that Mr. Newton not try to disguise that as a scientific question. People like Mr. Newton need to come to grips with the fact that climate change, like a contagious disease, is something we can and should do something about, and a price-signaling mechanism has been shown to be the best way to do that.

Now let's get on with designing a mechanism that will work most efficiently and not let the moral deficiencies of some stand in the way.

May 12 05:12 PM

[derryl:]

Newsflash!
After the 30 years of cooling from the 1940s to the 1970s that had climatologists warning of an impending ice age, we had about a 20 year warming trend that ended about 2001. "Global warming" has not been occurring for at least 8 years, and in fact data show a slight cooling trend.

LoebA: before you start foul-mouthing people like Danny Newton maybe you should spend more time researching climate data and less time listening to self-serving global warming preachers whose funding would evaporate if word got out global warming is not happening.

May 12 09:23 PM

[LoebA:]

To Derryl I will respond that the maxim "do unto others..." appears in almost every culture as a central principle, and for obvious reasons. The test of success Newton proposed is in complete contradiction of that.

And as for your comment, you are essentially saying that what people were capable of learning about the climate before they had high-powered computers is comparable to what people can figure out now that they do. And, taking your logic forward, you would also be saying that you can't trust doctors these days because medical practice before Pasteur thought disease was caused by "bad air" and so on. Sorry, I have spent a couple of decades reading the journals on the state of knowledge about such issues as it progressed over time, and it seems to me that we know something more now than we did in the 1940s.

And as for the "global warming preachers" who you say are doing this strictly out of self-interest, do you actually know any of them, or are you just ascribing thoughts and motives to people you have never met?

May 13 12:35 AM