Kate Mackenzie Cap-and-trade: Perennially unpopular

On the face of it, there are so many reasons to dislike carbon trading. Setting up a derivatives trading system to achieve something as morally and politically fraught as climate change just feels wrong, somehow, to many people. Still others (the Brookings Institution is the latest) argue that a carbon tax is superior.

Yet while the majority in most countries supports action on climate change, surveys suggest that attitudes to cap-and-trade are more ambivalent. Yet an HSBC survey last year showed that carbon trading simply doesn’t rate highly on people’s radars, when thinking about government action on climate change:

HSBC Climate Confidence Monitor

Source: HSBC Climate Confidence Monitor

So, given all the criticisms of cap-and-trade, why is it so popular with policymakers? To understand both the critics and the supporters, we’ll go through the key arguments against cap and trade:

But why create a whole new market?

This criticism falls into two camps; a moral opposition to the concept of trading international offsets (often from NGOs such as Friends of the Earth), and fear of a financial disaster.

As we’ve written many times here, the moral argument – that there is something bad about rich countries simply buying their way out of reducing GHG emissions - tends to overlook two benefits of international carbon trading: it transfers funds to developing countries, and reduces emissions in a more cost-effective way. The planet, after all, doesn’t care where emissions are generated, or reduced.

A stronger argument is that spending money in foreign countries simply postpones (or worse, avoids) the difficult work of shifting to a low carbon infrastructure. But in the short term, it’s often cheaper and quicker to reduce emissions in developing countries.

Another fear around carbon trading is that it could store up another market catastrophe, as carbon credits are essentially derivatives (an option to pollute), with all the potential for complexity and opacity of say, a collateralised debt obligation. As the FT’s Tony Jackson wrote earlier this week, carbon markets look quite simple and harmless today; but that doesn’t necessarily mean they won’t become more complex and risky down the track.

Deals to give away initial emission allowance allocations for free is another point of contention: often seen as a windfall for polluters, it is in reality more of a missed opportunity to raise revenue, but does not affect the emissions themselves, however unsound it might seem to let polluters off the hook for paying. Harvard’s Robert Stavins also argues that the giveaways are a pragmatic way to win political support for schemes to reduce carbon emissions.

A tax is better

One of the most compelling arguments against cap and trade is simply that a direct carbon tax is superior in many ways.  John Kemp provides one of our favourite outlines of this argument; The Economist also supports this line. A tax gives industry a much clearer price signal on GHGs – something many businesses around the world are crying out for - so they can more clearly plan how much to invest in reducing emissions. Building an expensive carbon capture and storage plant, or undertaking a building refurbishment, to reduce emissions, is all well and good - but companies need to know whether it is more cost effective to undertake those expensive efforts, and that is difficult without knowing what kind of price they will pay for their emissions if they fail to take any action.

So why cap-and-trade?

There are two main reasons that cap-and-trade so dominates the policy landscape. The clue to the first is the word ‘cap’ – by creating a specific number of allowances, governments can cap emissions; whereas a tax only lets the government set a price on emissions. To reach an emissions target through taxation requires a careful calibration of the tax level, and some opponents warn, risks a situation where the government, rather than the free market, decides the best way of reducing emissions.

Which leads to the other big pro-cap-and-trade argument: that creating a market system means emitters will find the cheapest and most effective ways to reduce emissions.

Related links:

Cap-and-trade versus everything else (FT Energy Source, 12/06/09)