Tuesday, February 06, 2007

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.


rabee said...

I don't fully understand Howard's proposal.

Will using Australian coal for manufacturing in Australia cost more than using Australian coal for manufacturing in say China?

It seems from the PM's comments on lateline last night that this will indeed be the case.

Won't many Australian producers simply want relocate their dirty processes overseas?

Taxing coal producers rather than consumers is probably the way to go.

hc said...

Rabee, I think the distinction is between taxing on an origin or destination basis. My assumption would be that Chinese emissions generated in China using Aussie coal would be China's problems and such exports would be tax or carbon quota free for Australia.

So on this basis your supposition is correct - Aussie coal used in Australia would cost more than Aussi coal used in China. And if Australia imported coal it would need too meet tax or quota requirements.

rabee said...


[We are a major producer of coal. Do we import much coal?]

So Australian's will have an incentive to relocate dirty production processes overseas, to say China: "a global environmental villain that funds its 10% GDP growth partly by imposing external costs on the rest of the world."

Once there they may even have an incentive to use even dirtier processes and impose external costs on the rest of us.

hc said...

I assume that we import almost no coal. I only mentioned importing to illustrate the destination accounting convention.

The idea used to be that it was fine to export polluting industries because developing countries had a loweer value of life, lower standards of environmental pristiness etc.

But you are right these global pollutants come back to bite us as externalities. A proposal I have argued in the past (following Joe Stiglitz) is to force China to internalise these externalities or deny them involvement in free trade agreements.

rabee said...

"A proposal I have argued in the past (following Joe Stiglitz) is to force China to internalise these externalities or deny them involvement in free trade agreements."

But that's not Howard's proposal. In fact if in response to Howard's proposal Australian polluters move processes to China, then China is likely to benefit and increase pollution.

A quick and dirty list of alternatives. We can tax
1) Australian coal
2) Australian polluters
3) Australian consumers at the checkout (estimate how much pollution was used to produce a good and tax appropriately)

I think that 1) and 3) dominate 2), which has economic costs and very little environmental benefits. If Australian polluters decide to relocate to say China, it may have an environmental cost. We lose both ways.

I can't see too many problems with 1). We're a small economy with market power in coal (I guess we are kind of a Saudi Arabia of coal). Taxing coal may reduce pollution globally even/especialy in China and perhaps increase overall revenue from coal (depends on whether we are already exercising market power). If international consumers of coal switch to nuclear energy, then all the better for us (they won't be switching to the other fossil fuel).

Anonymous said...

Interesting points Rabee. China (and the US) increase its comparative advantage if we unilaterally move towards carbon controls. At the same time they impose external costs on us.

The obvious move is for as many countries as possible to agree to carbon controls and to levy tariffs in the countries that don't. The EU is currently proposing to do this with respect to the US.

I think the issue is serious and that these are the drastic sorts of proposals that we should be putting on the table. The Chinese leaders are unresponsive totalitarians who don't care much about their own people let alone international opinion.