Green Economics 8/12

[Over an extended period ZNet has been publishing excerpts of chapters from Robin Hahnel’s latest book, Green Economics: Confronting the Ecological Crisis, available from M.E. Sharpe. Excerpts published here are not the full chapters which are made available inside the book. More information about the book and links to purchase it are below. Or, if you want, first, go to previous excerpts: Introduction / Chapter 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9]


Once we are free from the illusion that free-market environmentalism will protect the environment, we are free to explore the pros and cons of different policies that can. This chapter seeks to provide environmentalists and progressives who are not economists with the necessary information to correct common misunderstandings about what different policies do, and do not do. Hopefully this knowledge will render environmentalists and progressives immune from intimidation at the hands of technocratic economists who often do not share their values and priorities.


A Policy Primer


Suppose the U.S. government decides it wants to reduce national carbon emissions by 10% next year.

Regulation: The regulatory approach would be to order every source inside the United States emitting carbon dioxide to reduce its own emissions by 10%. Many economists object to this approach because it fails to minimize the cost to society of achieving a 10% reduction in overall emissions if there are differences in abatement costs among sources….

There is an additional problem with the regulatory approach that mainstream economists seldom point out, but that should be of concern to anyone concerned with equity. The regulatory approach does not require sources who, in our example, continue to emit 90% of the carbon dioxide they emitted the previous year to pay for the costs their emissions continue to impose on the rest of us. In other words, the regulatory approach does not implement the “polluter pays” principle, which many environmentalists and progressives champion with good reason.… Another way to look at the issue is that the regulatory approach implicitly grants sources a legal property right to emit 90% of what they were emitting previously, but cancels what had been their de facto property right to emit the last 10%. In other words, regulation creates a valuable new legal property right, gives 90% of this property right to those emitting carbon dioxide, reserves only 10% of the new property right for the rest of us, and bars everyone—both emitters and the public—from selling their new property right, no matter how beneficial a deal they might be able to find.

Tax: An alternative way to achieve a 10% reduction is to impose a tax on carbon dioxide emissions…. The logic of a carbon tax is to force producers to take into account the cost to society of their carbon dioxide emissions, just as they have to take into account the cost of using labor and scarce raw materials.

A carbon tax distributes reductions among emitters in a way that minimizes the cost of achieving the overall 10% reduction—sources with low abatement costs will do more of the total reduction and sources with high abatement costs will do less…. A carbon tax also explicitly makes polluters pay. It forces those who wish to emit greenhouse gases to pay the rest of us (in the form of a carbon tax) for using a scarce, valuable resource—space in the upper atmosphere where too much carbon is already stored. At least in theory, each citizen of the United States has an equal claim on the tax revenues of the federal government. So implicitly a carbon tax awards 100% of what was formerly an ambiguous property right that was habitually appropriated by polluters without asking permission—the right to release carbon dioxide into the atmosphere—to all citizens on an equal basis.

Tradable emission permits: While commonly misunderstood, each part of this policy is quite simple. Emission permits: Anyone emitting carbon dioxide is required by law to own permits to do so. If I am emitting 246 tons, and if a permit allows me to emit one ton, then I must acquire 246 permits…. Tradable: Anyone who owns a permit is free to sell it to anyone she chooses, and anyone who wants to buy a permit is free to buy it from anyone who is willing to sell it….

However, declaring these permits to be tradable in a free market is not the same as deciding how to distribute the permits in the first place. Many assume that when the government says there will be a market for emission permits, it means the government will sell the permits at an auction where all are free to come to buy. But this is not the only possibility and unfortunately has seldom been the case….

In many respects, tradable carbon permits will lead sources to behave in the same way a carbon tax does…. Under both a carbon tax and a cap-and-trade permit program, there is an opportunity cost when sources emit carbon dioxide…. and therefore at least in theory, tradable carbon permits yield the same efficiency advantages as carbon taxes—they minimize the overall cost of achieving a 10% reduction in carbon dioxide emissions–because they induce sources with lower reduction costs to reduce their emissions by more than sources with higher reduction costs….

A carbon cap-and-trade program takes an ambiguous property right—the right to release carbon dioxide into the atmosphere—and explicitly transforms it into a legal property right. Whereas this “right” was formerly appropriated by any who wished because nobody (who mattered) objected, under a cap-and-trade program the property right is encapsulated in carbon permits. If 100% of the permits are sold at auction, the property right is explicitly awarded to all citizens on an equal basis since all citizens, at least in theory, have an equal claim on the revenues of the federal government. However, if permits are given away free of charge—as they almost always have been—the new, legal property right is awarded to whomever receives them. Under the so-called grandfather system, the new property rights are awarded to those who are emitting carbon in proportion to their share of past emissions….

Monitoring and enforcement: If sources can get away with underreporting emissions so they do not have to purchase as many permits as they should, we obviously have a problem. But if they can get away with it, sources will underreport emissions to avoid fines under a regulatory program, and sources will underreport emissions to reduce tax liability in the case of a carbon tax. In other words, all three policies require authorities to know how much sources have emitted and establish effective penalties for violations. With regard to monitoring and enforcing, we could say all three policies are “created equal.”


Permit Markets: Dream or Nightmare?


The havoc unleashed by the crash of financial markets in 2008 has dramatically altered popular attitudes about markets. Now when people hear that a policy requires creating a new commodity that can be traded in a new market, many react with trepidation. Complacency about serious problems with markets prior to 2008 was, to put it mildly, naive….

The first point that cannot be over-emphasized is that in the real world there are both efficiency and equity reasons to prefer a carbon tax, which does not create a new commodity and market, over an equivalent cap-and-trade carbon permit program, which does…. However, sometimes circumstances may favor a cap-and-trade program over a tax, so it is important to be neither naive nor paranoid about what kind of problems real permit markets can create. In the short run, the problems with permit markets derive from what economists call “false trading.” However, there are larger potential problems in the long run if speculators become involved in the permit market. Because price volatility magnifies uncertainty with adverse effects on investment decisions, any bubbles or crashes in the market for carbon allowances would be counterproductive. And if a poorly regulated financial sector allows speculators in the carbon market to profit at the expense of the rest of us, as they were permitted to profit from the recent bubble and crash in real estate markets, the economy would become even more unfair than it already is.


Keeping Wall Street at Bay


There are only two ways to prevent the financial industry from ripping off sizable chunks of economic output while creating conditions that give rise to financial crises. The best way is to declare the entire financial industry too important to be allowed to fail—repeatedly—and so replace private with public finance. Accepting deposits and making loans to creditworthy consumers and businesses with sound investment plans is not terribly complicated. Only if one is trying to turn a simple industry into one that will make obscene fortunes for its investors and executives are complicated financial instruments and esoteric ways to increase leverage necessary. The only other way to protect the rest of us from Wall Street excesses is to restructure the financial industry and subject its various parts to regulations that are appropriate and competent. This is a second-best policy because, as history has just demonstrated once again, the financial industry is very adept at figuring out ways around existing regulations…. In any case, if we replace private with public finance or if we subject private finance to competent regulation, we need not fear that carbon allowances will become part of the next toxic financial cocktail.


Moreover, if we fail to reform finance in one of these two ways, it is almost certain there will be more financial cocktail crises, whether or not carbon allowances are one of its ingredients. In other words, we cannot prevent future financial crises by refusing to create certified carbon emission reduction credits. Future financial crises can only be prevented by successful financial reform.

However, consider a worst-case scenario. Suppose we create a global market for carbon allowances and offsets that climbs above half a trillion dollars a year. Suppose financial regulatory reform never happens. Suppose Wall Street does create a horrible cocktail of subsidiary markets around the carbon market—including carbon futures markets, markets for carbon swaps, derivatives based on fluctuations in the price of carbon, and whatever financial “innovation” Wall Street comes up with next. Suppose all these carbon futures, swaps, derivatives, and so on are packaged together with other opaque securitized financial instruments, based on other commodities, which nobody understands but eventually everyone comes to mistrust. In other words, suppose Wall Street mixes carbon allowances into a terrible, toxic, financial potion, and suppose this new asset bubble does burst with a vengeance.

This would be dreadful indeed. And if the financial crash were worse than the one that just occurred, it would lead to even more awful consequences for all of us who live on Main Street. But this is the important point: The financial collapse would not diminish the reduction in global carbon emissions one iota. Fluctuations in the price of carbon allowances and any derivatives based on those prices would redistribute income and wealth in mostly undesirable ways. And the price volatility for allowances that results would fail to send the steady, reliable price signal desired. But as long as laws and treaties requiring those who emit carbon to have the appropriate number of permits were enforced, the effort to reduce emissions and avert climate change would not be undermined.

In this worst-case scenario, what would happen is Wall Street would siphon off a big chunk of world product—first by trading in toxic assets that include carbon allowances as a bubble built, and then by shifting the cost of the financial cleanup onto the rest of us when the bubble burst. But this has nothing to do with the number of carbon permits in existence, and therefore nothing to do with how much carbon can be emitted. Moreover, such a financial crisis would not be the fault of the carbon market. This tragedy would be due entirely to the failure to either nationalize or subject the financial sector to competent regulation. It is highly implausible that denying Wall Street access to one new commodity, carbon allowances, would prevent future financial crises if the financial industry remains free from competent regulation.


Green Economics: Confronting the Ecological Crisis by Robin Hahnel is available from M.E. Sharpe.

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