EnviroEconomics.ca

I am not sure what this writer was thinking when this article was published in the Globe and Mail. Essentially the author argues that cap and trade will necessarily result in freeriders and hot air and therefore should be scrapped. While the case on freeriders and offsets may be a good one, railing against cap and trade seems dubious,

“with the shutdown of numerous uncompetitive industrial facilities following the demise of the Soviet Union, Russia has enormous carbon credits for sale. With little that can be done to reduce emissions from their already state-of-the-art facilities, economically struggling European manufacturers end up sending billions of dollars to Russia.”

Russian hot air was created because Russia was over allocated. Simply, there was no adaptive capacity in the cap setting to allow for the collapse of the soviet economy and the subsequent creation of fake emission reduction credits that could theoretically be used for Kyoto compliance by other Annex I countries. Most well designed cap and trade systems have closure provisions, where there are “use of loss” rules that require credits from closure to essentially be clawed back. So, design could have dealt with the hot air, and it was not an inherent flaw in cap and trade that led to this particular outcome but rather poor policy design.

The article then goes on to say that instead of cap and trade, a series of performance based regulations should be set for individual plants. A provision for a technology type fund is then mentioned, which is good for cost containment (i.e. a price cap that mimics a carbon tax),

The first step is to implement predictable, long-term, progressive targets for emissions reduction tied to each unit of a plant’s output. … Canadian businesses who fail to meet their targets could pay a set price per excess tonne to a federally administered emissions fund. This pool of cash would be designated to specific national environmental objectives; for example global warming adaptation and mitigation studies, energy-efficient city design including densification and public transit, or programs to encourage personal emissions reduction such as home energy efficiency improvements.

But, this is essentially a transfer to government and not between industry, which has obvious political and frankly economic efficiency questions. Adopting the freerider argument one can see a technology fund leading to all kinds of weird and whacky calls on revenue (see post here on carbon tax for Toronto) and high cost and low effectiveness investments. A technology type fund is good, but we are talking billions and billions of dollars in revenue.

Perhaps of bigger concern in this article is the rallying against abatement flexibility. The central premise of cap and trade is to allow emitters to smooth marginal costs. One emitter over complies, one under complies, the latter compensates the former and both are better off. This flexibility leads to innovation and continuous improvement and other good stuff. Stifle this flexibility and higher costs are inevitable.

So, if Canada is to achieve the reductions laid down by the federal governments or the provinces, flexibility is required. Flexibility in policy, flexibility in access to cheap reductions either domestically or internationally and flexibility to adapt to changing circumstances. And domestic reductions at increasingly stringent targets are really really expensive. So before we collectively dis those foreigners, perhaps we should shake their hand and see if there are credible and cheap reductions to trade.

As word of the all night negotiating binge was broadcast far and wide, there was cause for celebration. It turns out that the developed world was not so far apart and that language in Bali could be agreed upon. So, instead of binding reductions of say 20% to 40% by 2020, they settled for “deep”. The US grooved, the Europeans waltzed and voila, a road map for more talks. But can we afford to dance?

The developing world says no:

“We need to grow, and we need to grow rapidly,” said Munir Akram, a Pakistani diplomat who heads the G77, the major bloc of developing countries at the Bali conference.
“It’s a question of justice and humanity,” he said. “We cannot afford to allow our development to be stalled or reversed.”

But in Canada does this affordability refrain make sense? For some, like the manufacturing sector or low income households, climate policy needs to be concerned with income effects. Practically, this means that climate policy needs to separate the emission signal from compensating due to income concerns. For example, a broad-based emission signal, like a carbon tax, could be complemented by measures to compensate on the income side. This could be done through recycling revenue from a carbon tax or auctioned permits (from cap and trade) to those most adversely affected, like trade exposed sectors or low income households. This does not mean that we exempt some sectors from the price signal all together, and shift the cost burden to the rest of us.

But what about the rest of us, can we afford “deep” reductions? Nic Rivers and I have been doing some modeling using a macroeconomic model of the Canadian economy and find that deep reductions will cost, but will not ruin. We find that at emission prices of say $100, national GDP impacts are small and in the order of 1% to 1.5%% below a “no climate policy” level, which is less than forecast growth. With some creative tax shifting and revenue recycling (reducing labour taxes for example), this can be more or less halved. For this cost, we get emission reductions of about 20% below current levels, which is the federal government’s Turning the Corner target.

So, even with deep reductions, we will continue grow and have the national income to compensate those most adversely affected. But, just like the Bali-two step, I suspect that climate policy will continue to be one step forward and two steps back.

Chris Green, that quirky economist, has a good article in the Globe today on why the focus on targets is bad, and a focus on action is needed. His basic premise is that targets, especially long-term ones, are set in a political arena, which operates in the absence of clear information on the doable. Targets are then set beyond what is technically or economically achievable, and thus set to fail. The setting of targets also detracts considerably from the focus on action, and the inevitable failure influences implementation. Both of these observations are borne out in Canada’s Kyoto experience.

Chris makes some good sense, but I also think the long-term targets provide a focus for action. A well balanced climate policy would have one track that looks forward to vision where we need to go and how we need to organize and transform ourselves to transition to a lower carbon future. Another parallel tract would focus on short-term action and on setting the stage for longer term strategies to move towards the targets.

So Chris is bang on when he states:

Someone has to lead. Another round of climate target-setting would be a prescription for another decade wasted. While it may be politically difficult to chart a new course, there is no alternative if we wish to cope with climate change. Canada could at least get out in front with projects and policies — putting a price on carbon, strengthening energy efficiency standards, and increasing carbon capture and storage — that have a strong probability of encouraging development of the green technologies that will be essential to reducing greenhouse-gas emissions, even if the timing and magnitude of these reductions is inherently uncertain

I just think part of that leadership also involves rallying around a vision of the future. And that vision has to be anchored in where we need to be. So, we are stuck with targets. But as Chris points out, if we channel some of that energy used to argue over targets into action, we would be one our way.

The climate change policy debate in the media and behind closed doors goes something like this…”it is too expensive, we can’t afford it.” I call this “globe and mail” economics, where questions of affordability dominate and questions of benefits aren’t asked. This is happening in Bali now (see here) and it is certainly going on in Canada. But does this focus on affordability matter?

From an economist’s narrow efficiency lens, it does. The economist would prefer a policy that enables cost-effective reductions at the level of abatement where the costs and benefits are balanced. While economists have said quite a lot about the merits of emission pricing to enable cost-effective reductions, there is less of a contribution to the policy discourse on the desired level of abatement. Simply, information on the scope and scale of the possible benefits of action are too uncertain to lead to recommendations of policy stringency.

As a result, our climate debate is informed by a conceptual understanding of the abatement or adaptation benefits but a very acute understanding of the costs.

Because of this information asymmetry, it is likely that we will continue to be locked into a policy cycle of questioning the appropriateness of action to attain targets, regardless of their stringency. Indeed, without a balanced view of what we get for what we spend, we will continue to set targets, discuss policy options, reveal the associated costs and then ultimately question the affordability and distributive impacts of target attainment.

As climate policy transitions to a longer view, as it has under the Regulatory Framework’s (Turning the Corner) that aspires to substantial reductions by 2020 (-20% below current) and 2050 (-60% to 70% below current), this lack of a balanced view will become particularly acute. This is because the scale of the action implied under these longer-term targets is substantial. With a Canadian economy about doubling bymid-century and a GHG intensity that is only moderately declining, total Canadian emissions will about double by mid-century. To achieve the mid-century objective, therefore, GHG intensity improvements will need to be 20 times greater annually than the forecast no climate policy levels. And recent modeling suggests that emission prices will need to rapidly climb to in excess of $200 per tonne of CO2e to hit the targets. The need for such costs to achieve domestic abatement targets will only intensify domestic questions of cost, affordability and distributional impact.

So, an important climate policy challenge for Canada and indeed globally is to reveal the benefits of action and then, perhaps, the climate debate in Canada can proceed in more balanced and measured fashion. But then again, economic ruin is a better story.

When the Canadian government laid down some long-term aspirational targets, many argued it was a ploy to detract from taking action in the present. At the time I thought the government should be applauded for looking beyond the next election and out to where we need to be mid-century. When we peer out that far, we can understand the breadth and depth of the change required to achieve the significant targets they announced (-20% below current in 2020 and -60 to 70% below in 2050). Importantly, looking out allowed Canada to see some risks, four of which are notable:

Delay is costly. Analysis indicates that when climate policy is delayed, it becomes more expensive later on. Simply, we are stuck with high emitting capital that is costly to convert to low emitting capital;

Delay has target attainment risk. Again, the longer you delay, the more risk there is that your high emitting capital stock can’t be switched out for lower emitting stock, and thus affordability and technological limits increase the risk that future targets can’t be obtained;

Technological change is slower. Without price certainty on carbon there is no incentive to innovate and invest in R&D. This means that new technologies may not emerge that can help later and reduce costs;

More cumulative emissions. While targets are fine carbon is a stock pollutant and with delay in action you emit more, even if targets are attained. Thus, delay results in more cumulative emissions, which is a bad thing.

With Canada’s position in Bala (see here), the underlying current, whether intentional or not, is delay. But delay on global action will end up costing everyone more and lessening environmental effectiveness. For now, I still think looking out to mid-century is a good thing. I am just wondering when a vision of the future will emerge in current climate policy.

Watching Canada’s international position unfold in the lead up to Bali I had to admit that getting the other large emitters to come on side makes perfect sense. Saying that China, India and others can pollute at increasingly higher rates unhindered now because the industrialized industrialized world did more in the past is absurd. Carbon emissions from newly industrialized countries will trigger future costs and all tonnes are created equally. And competitiveness impacts in some industries are important. So, emission reductions are justified and the world needs to bring China and India into the fold.

And then there is us. Yes you and me. Jeffrey Simpson has a column correctly pointing the finger at us consumers. If one takes the emissions embodied in China’s exports and allocates them to the industrialized world, we apparently account for a full third. Not surprising to anyone who uses a credit card in North America. So, we are also a big part of the problem outside of our borders.

So moving forward post-2012, the big challenge will be the newly industrialized world, as Simpson correctly points out:

An international climate-change treaty that somehow doesn’t include China (and India and the U.S.) agreeing to emissions reductions will be a failed treaty. When the real negotiations begin in 18 months or so — Bali not being serious talks — getting those countries to sign on will be the hardest part of all.

This is why leadership through action by the industrialized world is so important. One can’t occupy the international moral high ground when one is wallowing in domestic carbon. But so long as Canada and Canadians continue to point fingers at others, our international position will sound as shrill as a carbon policy debate in the House of Commons.

Canada’s real climate policy challenge, therefore, is to stop pointing fingers and do a little hard work for a change.

While we in Canada dig out from three cross-county storms and our GHG emissions peak as all those two stroke snowblowers and plows make life more mobile, one can only think wistfully of Bali and those lucky few climate intelligentsia. Of course there is serious work to be done, and those tasked with working through the current political minefield will be working 24/7. While visions of post-2012 allocation schemes dance in their heads, there is a new and perhaps interesting twist — a call for a global carbon tax that will emerge from Bali.

Given a past political bias towards emission taxes, the emissions price that will continue to dominate the international GHG mitigation regime is of course emission trading. But this bias is not universal, and has ameliorated over time, and thus we now see a range of national and sub-national polices that implement emission taxes. This means that we are moving into a climate policy world where emission pricing is conducted by a mix of carbon trading and carbon taxes, with instances of both implemented concurrently (BC for example). It is not just the economists who are advocating for global carbon tax as part of the post-2012 international regime, but politicians as well. But the question is, can these two emission price options — taxes and trading — be reconciled in a post-2012 global regime? In this post we argue there are a number of reason why the answer is yes.

From an economist’s perspective, the options are reconcilable since both can be designed to mimic each other to ensure similar economic and abatement outcomes are achieved. An oft cited example of this “mixing and matching” of design elements is where a “safety valve” can remove the price uncertainty associated with trading so that total abatement costs are limited. Similarly, an emission tax can be updated up or down so that observed emission outcomes align with desired reduction targets. The advice from economists, therefore, is that the decision to move forward with emission pricing is not an “either/or” decision, but instead how to mix and match these inherently complementary price signals.

This assertion has important implications for the feasibility of a global carbon tax, for if emission taxes and trading are complements, there is scope for a carbon tax in the international regime. But why would it would be appropriate to implement the emission price policies as complements in the post-2012 regime. There are a number of reasons:

• Post-2012 allocations will remain contentious and will take time to sort out, and hence there is an opportunity for a global carbon tax to speed the transition to broader and deeper carbon reductions.

• A global carbon tax could transition newly industrialized countries to the post-2012 regime with binding caps.

• Institutional feasibility in the developing world more closely aligns with taxes rather than trading.

• Competitiveness issues can be lessened if a global carbon tax can be implemented in advance of global emission constraints.

Of course, some political support for a global carbon tax may do little to address “carbon tax” as a four letter word in politics.

Once again we see “Globe and Mail” economics dominating the climate debate, where the costs of action and the threats of adverse competitiveness impacts drive the discourse. What Minister Baird is saying here, is that our abatement targets are going to drive firms out of Canada:

“If we simply move production from Canada and the European Union to China or the United States, we won’t have accomplished anything for the environment.”

Well, recent modeling completed by MKJA and myself indicate that the large final emitters would see production cost increases of about 1% in 2020 from a 25$ emission price, and would rise to about 3% at ~75$, the minimum emission price needed to hit the current government’s Regulatory Framework targets (-20% from 2006 in 2020). So, are cost differentials of about 3% on products enough to trigger companies to put their production lines on a slow boat to China? If this is the case, Canada has a much larger productivity issue that should, perhaps, be the focus of more political hot air and broadsheet ink. But, since productivity is not the burning issue, perhaps Canada could move forward for a change.