Market based instruments to address climate change

12 July 2012
ITC News

Recently, Professor Stavins of Harvard spoke at ITC as he was attending a GTAP conference ITC was co-hosting with the WTO and UNCTAD. For an hour, he spoke about climate change policy as well as touching on trade issues. This post relates to Professor Stavins' comments on market-based instruments and political economy:

Market based instrument best to address climate change

Stavins made a strong case for market-based instrument to mitigate climate change. There are millions of emissions sources (from cars to lawnmowers to power station) with hundreds of millions of decision-makers. Each source has a different short term marginal cost to reduce emissions.  Conventional command and control policies (e.g. emission standards) are not cost effective because they impose a regulation that requires compliance in different marginal costs. Market-based instruments like a carbon tax or cap and trade controls emissions at the same marginal cost. In the longer term, pricing sends signals for low carbon technology development.

Carbon pricing is a necessary but not sufficient incentive for low carbon tech development. Why? Because R and D is eventually a public good, even with strong IP systems. For example, Apple spent millions on developing the smart phone. New entrants to the market (Android) have enjoyed the benefits of that development. Apple did not capture all the benefits of their investments. So positive externalities mean that low carbon technology development will be undersupplied without government funding.

Why market instruments are difficult politically

He said a meaningful climate policy was “impossible” before 2013, although there is some climate policy in the US, e.g. Energy efficiency standards for auto and appliance; US Supreme court decision making CO2 a “pollutant”; air pollution policies for correlated pollutants.

Why is carbon pricing a hot political issue? Because it makes the costs transparent. Politicians want to make constituents think they have something for nothing. Win-win policies don’t exist. For example a gas tax is transparent. A fuel efficiency standard is less so, and so more acceptable politically.

The political tipping point for climate action

When asked about political tipping points for change (as described once by Al Gore), he was pessimistic that this would happen soon as voters need to see a "perceived or real crisis or disaster". For example, the US Clean Water Act was passed straight after the 1969 Cuyahoga River fire.  The cause of the fire was obvious and so makes the case for legislation clear. - the cause of climate change is not obvious to many people as "we observe the weather not the climate". How many residents of Washington D.C. suffering record high temperatures this past month without air conditioning linked high temperatures to climate change?

When asked about why legislation on CFCs was introduced, he said the following conditions were right:

  • The science was obvious to everyone
  • There were a small number of companies
  • There were no producers in developing countries
  • The main companies producing CFCs (Dupont) had already developed an alternative

Compare all that to the case of climate change:

  • The science is not obvious to voters
  • There are hundreds of millions of producers of emissions (making negotiations costly)
  • Many are in developing countries
  • There are not immediate substitutes in all aspects of the economy.

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