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OP-ED: Addressing emissions trading

  • Published at 11:14 pm April 17th, 2021
CO2-carbon emissions
File Photo: A view of the Jaenschwalde Power Station near Peitz, eastern Germany on November 30, 2019 AFP
'In contrast to near everything else I say about life and the economy I argue we should set the price and let everything else adjust'

Climate change is not the only air pollution problem we face – as anyone who has tried breathing the air in Dhaka on a bad day knows. The first important question is whether we want to do anything about this, the second well, if we do, then what?

Either form of pollution has costs, clearly. But there has to be a reason why we produce said pollution otherwise we wouldn't be doing so. After all, we are not all teenagers throwing things around to make the place look dirty just because it is fun. Some of us are perhaps, but not all. The answer being that the things we do that create pollution produce benefits for us as well as those costs of the pollution itself. Yes, trying to breathe Dhaka on a bad day provides a good lungful of coal dust but then we also like having the electricity from the power stations.

Given this existence of benefits as well as costs it is not true that we want to do absolutely anything at all to get rid of the pollution. Anything would include not having the electricity which produces it and we've all already decided we're not willing to give that up just for clean air. So, it becomes how much will we give up?

Which is where we start to enter the usual economic calculation – what is the optimal answer here? How much pollution, how much climate change, is the right amount? Umran Chowdhury approached this question in this newspaper and his answer led him to emissions trading schemes. One of our two possible answers to this question of how we reach the optimal amount. The other being a tax upon the pollution itself.

Well, the third way is regulation, that the bureaucrats tell us all what to do and how and that is a plan which has never really worked very well across human history. So, back to the two that we know might have a chance.

If we follow Chowdhury's idea of emissions trading we issue a number of licences that allow people to emit carbon dioxide – we are concentrating just on the climate change example here. Anyone whose process emits must have a permit. In accordance with the basic economics of asset distributions it doesn't matter who has them first, they'll end up being traded and the people whose process adds the greatest value will pay the most for those permits – therefore they will have them. So, emissions will be whatever number we've allowed through permits, the price is unknown, but we will end up with less valuable emissions disappearing and more valuable ones still carrying on. This is optimal – we have arrived at the best we can do to make ourselves as well off as possible. 

The other idea is to tax emissions. All emissions pay such and such an amount – the Stern Review says $80 per tonne CO2-e. We get some revenue for government, we still kill off low value emissions and retain high value ones. We are at least close to our optimal answer.

But note the difference here. One method sets emissions and leaves prices to find their balance, the other sets the price and leaves the level of emissions to adjust to that. A free marketeer like me, one red in tooth and claw, should prefer the permits and auction process to the set tax level one. And yet I do not, I come down on the other side from Chowdhury. In contrast to near everything else I say about life and the economy I argue we should set the price and let everything else adjust.

This is not, by the way, a critique of Chowdhury. Nor do I insist that you must prefer my plan to his. Rather, I want to explain that we live in what is called a “second best” world. One in which the better solution sometimes is not because of other features of the society around us.

The thing being that I have seen an emissions scheme being set up – the European Union one. And it was a morass, an orgy almost, of rent seeking and string pulling. Everyone who even knew the name of a politician was demanding the free issue of extra credits just to them. The result of those being that so many were issued that the price has been, for well over a decade, effectively zero. And prices of nothing tend not to limit people making emissions which is the point of the whole process in the first place. Thus my recommendation of the second best policy, set the price through a tax and make the world adjust to that. Simply on the grounds that “Here's the price, get on with it” is politically easier than having to fight one's way through every special interest group demanding favourable treatment.

Which is a sad commentary on politics perhaps but then this is a second best world.


The author is a senior fellow at the Adam Smith Institute in London

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