Climate change mitigation & the case for carbon trading

The 4th IPCC report on the scientific basis for global warming has been released and is being assimilated. It is an important document because it narrows the range of uncertainty over climate change as a policy issue. This gives conservative politicians, of all persuasions, incentives to act. There is a need to devise sound global policies which involve emerging countries such as India and China and domestic policies to achieve emission targets at minimum cost.

A basic tool for greenhouse gas management is a carbon tax or an equivalent carbon trading scheme as advanced by the Prime Minister John Howard. A tax can be levied to close the gap between the social costs of carbon emissions and their private costs. If the tax is set appropriately it will yield an efficient level of emissions. If we can observe emission levels by individual polluters, one can alternatively set this efficient emissions level as a target, allocate it among polluters, then allowing them to trade their quotas into their highest valued uses.

Although a carbon tax can, in principle, be designed which has the same effect as a quota there are well-known advantages to the Prime Minister’s scheme if, as is plausible, we are uncertain of how polluters will respond to a tax, but wish to guarantee that Australia will meet its CO2 targets. Moreover, this trading process will mean that those firms which face the lowest costs of limiting their carbon emissions will do so. Firms with high mitigation costs will buy quotas from these low cost firms so cleanup is done at minimum community cost thereby achieving an economically efficient outcome.

According to the AFR this morning (subscription required) the carbon trading market in Australia could be worth $4 billion annually.

To be clear a carbon trading scheme will provide the same signals encouraging nuclear power, other non-polluting technologies and energy conservation that a carbon tax would. It also has the political economy benefits of being less objectionable to polluters than a tax transferring revenue, in the first place, to government. The claim that quota schemes require monitoring of emissions is a weak criticism since so too does successful implementation of a carbon tax.

Because the effects of a carbon trading scheme on a firm's marginal production costs are analogous to the effects of a tax it is pure rhetoric on the part of PM Howard to insist that because he is choose a tradeable permits scheme over a tax that he is not 'selling out' the workers in the mining and power generation industries. An effective carbon trading scheme will have the same effect on electricity prices as an effective carbon tax.

PM Howard has signalled that a national carbon trading scheme will go ahead within 3 years provide there is a reasonable expectation other countries will follow suit. An announcement on the specific form of the scheme is expected tomorrow.

Meanwhile, I have been sporadically following the press debate in Australia on IPCC. Alan Dupont in The Australian sees climate change as a ‘security issue’ that threatens ‘mega-death and contribute to state failure, forced population movements, food and water scarcity and the spread of infectious diseases’. He claims climate change policy should be integrated with foreign and national security policy. Mirko Bagaric argues, to the contrary, that immediate issues of extreme poverty should have priority over speculative issues associated with warming since warming is a problem for affluent not poor countries. He further claims that because our ‘sympathy gland’ has finite size that more pressing issues of poverty in developing countries should be emphasised. This is a version of the Lomberg thesis and seems misguided since, in my view, the main costs of global warming, which could be cartastrophic, will fall heaviest on poor people in developing countries.