And of course, the entire discussion is occurring at a time of imperfect and rapidly evolving science as well as highly partisan perspectives. Issues of equity — such as whether rich or poor nations should bear the costs or whether today’s uncertainties justify the costs that future generations might bear — abound. Efforts to establish appropriate interest rates for cost-benefit analysis of alternative policies end up tangled in what appear to be irreconcilable contradictions.
Despite this issue’s many complexities, public support for action on climate change is wide and growing. Many nations have already adopted mandatory limits on CO2 emissions; so have numerous states, cities, and companies in the industrialized world. The debate over the cap and trade system in particular is moving beyond the question, Should we do it? to the multiple questions of how to design it. And here again there are disagreements: over the percentage of the emissions rights that should be given free to companies versus auctioned off; over the pace and severity of emissions reductions; and over the appropriate use of the proceeds by governments. In general, these debates come down to a question of distribution: whether to set up the details of allocation to favor particular geographies (areas dependent on coal-fired generation versus those amenable to windmills), industries (energy-intensive manufacturers versus service sectors), or types of firms (electric power companies with large nuclear and renewable portfolios versus those with mostly coal-fired units).
However, the heated quality of these debates can obscure a more fundamental issue related to the nature of markets themselves.
Emissions Market Omissions
Winston Churchill famously said that democracy was the worst political system, except for all the others. Something similar could be said about using cap and trade markets to reduce greenhouse gases. Markets may be imperfect and incomplete, but all the alternatives (at least individually) are worse. Classic command-and-control regulation would be massively inefficient and probably politically unpalatable. Carbon taxes are widely viewed as a political nonstarter, at least in the United States. And doing nothing, at either the corporate or the national level, is too risky a proposition.
As previously noted, cap and trade regimes were applied with great success in the regulation of acid rain, beginning in 1989. (See “The Making of a Market-Minded Environmentalist,” by Fred Krupp, s+b, Summer 2008.) Existing regulatory regimes in Europe, the U.S. Northeast, and California are using similar approaches. The benefits of these market-based regimes, compared with quantitative or technological mandates, are well known. Markets create price signals that allow billions of uncoordinated choices to be directed to reduce carbon, while inducing technological and business innovation, without the need for centralized control.
But the shortcomings of markets in reducing emissions cannot be ignored. First and foremost, as a recent Booz & Company survey of U.S. consumers showed, many people are unprepared for the energy prices they would have to pay under a cap and trade regime. It’s no surprise that in the U.S. Midwest and South, where electricity rates have remained steady or fallen in real terms for two decades and where political support for addressing climate change is low, people balk at the idea of steeply increased rates. But environmentally and socially progressive survey respondents in places like the Northeast and Pacific Northwest were also disinclined to pay higher prices for electricity or transportation fuel, even when told it would reflect the need to reduce carbon emissions. Instead, the research showed that consumers across the United States and of all political persuasions believe someone else — typically big business — should shoulder the costs. This suggests that attempts to foist price increases on consumers to reduce climate change would be politically unsustainable, perhaps depleting the widespread goodwill that is currently bestowed on action against climate change.