April 30, 2007
We need to bring climate idealism down to earth
By Lawrence Summers With the accumulation of scientific evidence and its persuasive presentation to the public, the global warming debate has reached a new stage. Those who still deny that human activity is warming the planet, or claim that “business as usual” can continue indefinitely without profoundly adverse consequences, are increasingly seen as the moral and intellectual equivalent of those who deny that tobacco has adverse consequences for human health. While there is probably excessive euphoria in some quarters over the economic benefit of green policies, it is now beyond debate that there are huge opportunities to reduce emissions with economic benefit or negligible economic cost. It has been estimated that worldwide subsidies to energy use approach $250bn. The real question for debate is not whether something should be done – that debate is over among the rational. The crucial question now is what should be done so as to leave our descendants with the highest possible quality of life. Answering it effectively requires vision and ambition. But, as the example of Woodrow Wilson’s League of Nations teaches painfully, utopian vision and ambition unmoored from political, economic and social reality can be counterproductive. There is a very real danger that the global cap and trade approach directed at achieving the rapid emissions reductions enshrined in the Kyoto protocol – now favoured by most European governments – could be ineffective or even counterpoductive by substituting for more realistic approaches to the problem. Kyoto is now the only game in town for those who do not want to be ostriches with respect to global climate change and so one has to hope for its ultimate success. But it is surely useful to try to be clear about the potential pitfalls, as I am in this column, and as a matter of prudence to consider alternative approaches if the Kyoto approach does not succeed, as I will in my next column. First, the Kyoto approach depends on the questionable premise that nations will, in fact, be bound by binding targets or penalties for not meeting them. It is instructive in this regard to consider the history of the Maastricht Treaty within the European Union. It addressed fiscal targets directly under the control of governments over the relatively short term within a group of countries that had already achieved a high degree of cohesion. It broke down almost immediately when it looked like the targets would not be binding for big countries, with the goals abandoned and no payment of even the modest penalties. There is to date little evidence that Kyoto is driving behaviour. Whatever evidence there is of impressive emissions reductions comes from countries such as the UK, Germany and the former communist states, where coal use was being phased out for other reasons. The limited impact of Kyoto is evinced by the fact that carbon permits are now selling in the range of a negligible one euro a tonne. Second, carbon markets are invitations to engage in pork-barrel corporate subsidy politics on a massive scale. If greenhouse gas emissions are to be substantially reduced, the value of the associated emissions rights will be in the tens of billions of dollars. While in principle emission permits could be auctioned, in practice they are always allocated administratively. It should not be surprising that businesses that can pass on carbon costs to their consumers are excited about schemes that compensate for these costs by allocating them permits related to their existing emissions levels. As investigations by this newspaper have highlighted, the clean development mechanism has resulted in substantial payments for emissions reductions that would have occurred anyway or could have been achieved at negligible cost. There is even reason to think that certain industrial gas emissions may have been increased so that credit could be claimed for their abatement. Third, the most serious problem with the Kyoto framework is that it is unlikely to generate substantial changes in developing country policies. As my Indian hosts explained on a recent visit, developing country policymakers are not likely to accept binding targets on their energy use or greenhouse gas emissions that fall way short on a per-capita basis of emissions levels in the industrial world. Nor is it reasonable to expect them on the basis of dubious projections of economic trends and future technological developments to commit to energy use goals that fall short of patterns observed in the rich countries. The truth about climate change policy is that developing countries are where most of the future action has to be. They will account for 75 per cent of the increase in emissions over the next quarter century and are now making the infrastructure investments that will shape their future economies. Moreover, any international regime that does not include them will not work because emissions reductions in the industrial world will be offset as energy intensive activities relocate to the developing world. The 1997 vote cast by all the Democrats in the Senate suggests that approaches that do not involve the developing world are unlikely to command political support in at least some parts of the industrialised world. Perhaps these problems and others, like the difficulty of establishing emissions targets given the magnitude of economic uncertainties, can be overcome with goodwill and extensive thought. But next month I shall suggest approaches that, while less dramatic in their immediate claims for emissions reductions, may over time provide a more secure foundation for the progress that the world must have.
Lawrence Summers Slams Climate Idealism
Lawrence Summers slams climate idealism in the Financial Times of Londan today.
Posted by: Ora et Labora | April 30th, 2007 at 2:49 pm | Report this commentThe crutial question now is what should be done so as to leave our decendants with the highest possible quality of life. Answering it effectively requires v…
Willem Buiter: Larry wants to bring down to earth a climate idealism that, unfortunately, is already below-ground. Unlike him I believe that, with the right kind of leadership by the new G7 (the USA, the EU, China, India, Brazil, Russia and South Africa), the world can be encouraged to launch a much more ambitious attack on environmental problems in general and climate change in particular, than he can currently envisage. At the same time, Larry’s criticism of the current implementation of ‘cap and trade’ fails to distinguish between the principle of ‘cap and trade’ and the ‘offsets’ policy that has been spliced to it. Cap and trade is eminently sensible and desirable. Carbon offsets are an abomination. Fortunately, the two can be uncoupled from each other.
Posted by: Willem Buiter | May 1st, 2007 at 11:04 am | Report this commentThere are just three ways of reducing carbon dioxide and other greenhouse emissions. The first is command and control methods: the setting of quantitative limits for individual emitters. For this to work, the authority setting the limits must be capable of monitoring actual emissions. It must also be able to set the most efficient quantitative emissions ceilings for each individual emitter. There was a reason central planning failed. That information is not and cannot be centrally available.
The second method is to end all subsidies to energy use and to tax all carbon or greenhouse gas emissions (at a uniform rate for a given category of emission). This too requires the monitoring by the tax authority of actual individual emissions, but it does not require the tax authority to know the optimal level of individual emissions. Fuel taxes could be effectively used for this purpose to limit emissions by motor vehicle users.
The third is cap and trade. Some Carbon Emissions Authority (CEA) sets an overall limit on the amount of greenhouse gases that can be emitted in its jurisdiction during a given period (the ‘cap’). A commensurate fixed amount of dated carbon/greenhouse gas emission permits is created. The fixed amount of dated carbon emission permits is then rationed out among the target population of emitters (mostly enterprises). The only sensible way to ration the permits is to auction them off. Larry is absolutely right in highlighting the insurmountable problems associated with administrative allocations: pork barrel corporate subsidies at best, outright deception, fraud and corruption at worst. Allocating permits on the basis of current or recent past emission levels is in addition likely to encourage an immediate boost to emissions, in order to qualify for larger future permit allocations. A secondary market in greenhouse gas emission permits is clearly efficiency – enhancing (the ‘trade’).
Like taxation, cap and trade requires the authority (here the CEA) to be able to monitor actual emissions. It is not a criticism of the principles of the cap and trade approach that the EU screwed it up last year, in Phase I of the EU’s Emission Trading Scheme, by setting the overall emission limit at too high a level, resulting in a near-zero price for carbon emission permits. If you set a tax at zero you will not influence behaviour. That does not mean behaviour would not be affected if you set the tax at a higher level.
It is absolutely essential that the sound and sensible idea of cap and trade be uncoupled from the notion of offsets. Under the various offset schemes we now suffer under, it is possible to earn carbon credits by engaging in activities, schemes or projects that will result in lower carbon emissions than would have occurred without these activities, schemes or projects. Note that for offsets to work the authority needs to know not just the carbon emissions that will actually occur because of the project. That is the same information required for carbon taxes or cap and trade. The authority in addition needs to know the carbon emissions that would have occurred had the proposed project not taken place because of the absence of the offsets. Only by comparing this counterfactual carbon emissions volume with the actual emissions of the project for which an offset credit is being claimed, can the authority determine the amount of carbon emissions that has been saved or prevented as a result of the project. This is that difference that provides the basis for the offset credit.
It is, in practice, virtually impossible for any outsider to determine the ‘additionality’ of a project, that is, the amount of carbon emissions that would have occurred without the project compared to the amount of carbon emissions that occurs with the project. Only the insiders, that is the sponsors, promoters and financial beneficiaries of the project, have any hope of knowing to what extent, if any, the project saves carbon emissions and is additional.
The predictable result has been a proliferation of bogus schemes - an orgy of phoney carbon emission reduction claims. Trees may or may not have been planted in former rainforest areas. Even if they have been planted, their additionality cannot be certified. Like European and American farmers who are paid not to grow things, offsets have been awarded for not cutting down trees (how many trees did you not cut down today, daddy?). Claims have been made under the offsetting schemes for the installation of industrial filters and scrubbers that might well have been installed without the schemes. But who, other than the parties proposing these schemes, is likely to know for sure, etc. etc.
The UK Secretary of State for Environment, Food and Rural Affairs, David Miliband pledges his department’s support for “the development of robust, transparent, reliable and timely carbon offset products that offer buyers genuine value for money and certainty that an environmental benefit has been achieved.”(Financial Times, Letters, Monday April 30, 2007). His department’s forthcoming final code of best practice for offsetting may indeed be best practice, but it is not enough to be best practice when the best is bad and not good enough.
The ultimate as regards fatuous environmental gestures is the purchase of carbon offsets against ‘carbon footprints’. To calculate my carbon footprint, I would have to know the direct and indirect generation of carbon emissions associated with my consumption or production activities. When I buy my green organic vegetables, I will have to allow for the fact that cow manure was used in their production. Cows are notoriously flatulent animals producing vast quantities of methane – a greenhouse gas. During the cold season these cows are likely to have been housed in centrally heated barns (courtesy of the Common Agricultural Policy) producing carbon emissions in the process. The barns may well have had aluminium sidings. Aluminium is produced using some of the most energy-intensive processes known to mankind, etc. etc. In short, I would have to know the entire greenhouse gas emissions input-output matrix of the UK and global economy to calculate my carbon footprint. The most recent UK conventional input-output matrix dates from 1995. Unfortunately, it is neither customized to my consumption pattern nor contains any information on carbon emissions at the various stages of production. Buying an offset for my carbon footprint is using something counterfactual and non-verifiable to compensate for something I cannot begin to calculate or estimate. It is creating a vast bureaucracy and a growing industry of rent seekers engaged in the privately rewarding but socially unproductive activities of designing, certifying and verifying offset schemes. It is key that the whole offset industry be decoupled from the eminently sensible and desirable cap and trade idea, and that the offset industry be killed off immediately.
Cap and trade or the taxation of greenhouse gas emissions can produce equivalent desirable environmental results by reducing carbon emissions. Provided greenhouse gas licenses are auctioned off, both cap and trade and taxation will produce revenues. If the tax is set high enough and/or the quantity of greenhouse gas licenses is set low enough to achieve even modestly ambitious environmental ambitions, such as the reduction of overall emissions of greenhouse gases by at least 5 percent below 1990 levels in the commitment period 2008 to 2012 of the Kyoto Protocol, massive revenues could be generated. To make greenhouse gas emission reductions palatable to developing countries, the bulk of these revenues should be transferred to the developing countries, to use as they see fit. Only through such resource transfers will the rich nations of the world be able to convince much poorer countries to contribute to the cost of internalising the global externalities of greenhouse gas emissions.
Martin Wolf: This is a fascinating discussion. Let me start by noting two fundamental points of agreement.
First, I am entirely persuaded by Willem’s argument that so-called “offsets” are an absurdity, ripe for fraud and entirely meaningless in practice. The aim, I presume, is to obtain some reductions in emissions in developing countries. But, without some overall limit on emissions in these countries, there is no reason to expect the offsets to have any effect on emissions at all. The reason is obvious: the incentive to create emissions that can then be “cut” as part of the offset. These then are phantom cuts of phantom emissions. The schemes are a joke.
Second, I agree with Larry that the collective action problems are hugely difficult to resolve.
In addition, there is no disagreement, I presume, that any cap and trade system should be based on the auctioning of permits. The allocation of quota rent to existing polluters is unconscionable. Personally, I am persuaded that common taxes would be better than a global cap and trade system, because, properly set up, it would give price predictability in the medium term and could, with an appropriate feedback rule, give emission predictability in the long run. That is the combination we need. A common rate of tax would also generate revenue for each country to use as it saw fit, though there would presumably still need to be transfers across borders, to compensate developing countries for the costs they would bear by imposing the tax.
One small further point: Why does Willem exclude Japan from his new G7? It is the third largest economy in his list at market prices (after the US and EU) and the fourth at purchasing power parity (after China, as well, though India must now be quite close).
I look forward to Larry’s answers.
Posted by: Martin Wolf | May 4th, 2007 at 3:19 am | Report this commentWillem Buiter: Martin’s right about Japan. G8 it is, then.
Posted by: Willem Buiter, London School of Economics | May 4th, 2007 at 9:47 am | Report this comment