Friday, June 27, 2008

Climate change: why an ETS?

Over on Truthseeker, Steve asks why trade emissions credits anyway?, and suggests we might want to consider alternative policies:

Legislatively mandating emissions reductions to an open and transparent regulatory schedule and NOT operating a market may actually be cheaper and ultimately more effective than an ETS.
So, why are we pursuing an ETS rather than command and control measures? In this post, I'll try and give an answer; in a future post, I'll try and give some ideas about what a regulation-based policy would look like.

Firstly, terminology: "Command and control measures" is policy-speak for Steve's "open and transparent regulatory schedule" - things like mandated technologies, zoning regulations, and input or output controls (e.g. banning toxic chemicals) which work primarily through regulation and the threat of sanction. They are traditionally contrasted with "economic" or "market-based" instruments such as cap and trade, carbon taxes, or waste charges, which work through the price mechanism. I don't want to recap the whole "regulations vs free markets" debate here, but both have advantages and disadvantages. With command and control measures, you get certainty - you know what you are banning, and you know that it is actually banned. Against that must be set the danger of perverse incentives, capture of regulation by lobbyists, or that regulators may not know enough about the subject to regulate the right things (though see previous). Economic instruments solve the latter problem by getting markets to work for you and find ways to reduce whatever it is you want to reduce that regulators may not have thought of, but at the cost of introducing uncertainty - there's always a danger that polluters will simply pay the price and keep on polluting, especially if they are in a position to pass it on to their customers.

While I have a slight preference for (certain types of) market instruments because they implement the "polluter pays" principle, and dump the social costs of pollution on those responsible, its not actually an either-or question. Other countries, such as Norway have pursued mixed policies with great success. IMHO, which is better is simply a question of effectiveness. It might very well be that regulation would produce better climate change outcomes than the ETS - that really depends on the strength of the former and how many holes there are in the latter.

Unfortunately, that is decidedly not the view of the New Zealand policy community. During the 80's, that community was captured by a radical clique of free marketers, with a rigid belief that government cannot do anything right and that markets are always and everywhere superior to regulation. And those views have utterly dominated climate change policy. While regulatory solutions were floated early on (e.g. in the 1990 report of the New Zealand Climate Change Programme 's "policy" working group), they were quickly discounted. Instead, policymakers became fixated on the idea of a "least cost" solution, which axiomatically ruled out any possibility of regulation from the get-go. We've stayed on that path ever since. One of the consequences, though, is that in our quest for a pure, perfect, least cost policy (alternatively a carbon tax (1994), then emissions trading (1999), then a carbon tax again (2002), and now back to emissions trading (2007)), there has been no interim policy while we work out the final details of our economic instrument - we've been shackled to this purist market vision. As a result, we haven't actually done anything to reduce emissions. The perfect has very much been the enemy of the good.

So, ideology and an insistence on an optimising rather than "good enough" solution is the long-term answer. Added to this, there's also a hefty dollop of political convenience. In the wake of the 2002 carbon tax, emissions trading seemed easier to sell to a hostile business community than regulation. Finally, there's the need for an immediate solution: we're pursuing an ETS at the moment because we need policy now. While we could tear it all up and start again, given the length of the policy cycle, that would delay any action by at least two to three years. And we simply can't afford that sort of delay. The government's ETS is a long way from perfect. It's ugly, it gives handouts to polluters, and doesn't do nearly enough to curb emissions in CP1. But it is "good enough", and delivers substantial long-term environmental benefits. And given a choice between that and a further delay to design and implement a perfect regulatory regime, I'll take the bird in the hand any day.