Reflections from Cambridge on the Climate Talks in Doha

Ever since I returned – some two weeks ago – from Doha, Qatar, the site of the Eighteenth Conference of the Parties (COP-18) of the United Nations Framework Convention on Climate Change (UNFCCC), I have planned to offer some commentary on this year’s annual climate negotiations, including the principal outcome, namely, the “Doha Gateway.” I decided to wait, mainly in order to put some geographic and temporal distance between the conference and my thoughts, so that I could reflect on “the forest,” rather than enumerating “the trees.”

Then, a few days ago, a reporter from the Harvard Gazette, Alvin Powell, came to my office to discuss this very subject. Having covered this and related topics for a number of years, he has considerable background on both the science and the policy. And he had done his homework to prepare for the interview. When I read the published result just now in the Harvard Gazette, I realized that this is – in fact – the reflection I had wanted to write for readers of this blog. So I’m offering it here.

The interview started with a quick history of climate negotiations, a brief description of my own role at COP-18 in Doha, and then an assessment of the conference’s outcome. From there, the conversation became more freewheeling, with Mr. Powell asking me about the status of U.S. climate policy, as well as the potential role and responsibility of a major research university such as ours. At the end of the interview, we returned to reflections on the slow pace of international climate negotiations.

You can read the original version in the Harvard Gazette here, but I also offer the published version below without any editing (but with the addition of some hyperlinks for interested readers).

Climate change on world stage

Q&A with Robert Stavins on prospects for adopting a plan to confront it

By Alvin Powell

Harvard Staff Writer

Wednesday, December 19, 2012

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File photo by Stephanie Mitchell/Harvard Staff Photographer

“My view is that the best thing that Harvard can do [to combat climate change] is to carry out first-rate research, combined with the best possible teaching, and effective outreach to the public sector and the private sector. That’s our comparative advantage,” said Robert Stavins, Albert Pratt Professor of Business and Government at Harvard Kennedy School.

International climate talks wrapped up last week in Qatar. Harvard Professor Robert Stavins attended and characterized the gathering as a qualified success, representing another step in a long process of reaching a workable international agreement.

Gazette staff writer Al Powell talked with Stavins about the work of international delegates and the prospects for a meaningful agreement going forward.

GAZETTE: Can you explain the purpose of these talks?

STAVINS: In 1992, at a United Nations conference in Rio de Janeiro, a major outcome was the adoption of the United Nations Framework Convention on Climate Change. Among other things, that convention provided for annual conferences at which representatives of countries would get together to discuss and negotiate how to address the threat of climate change. These annual negotiations go by the name of a “Conference of the Parties,” commonly abbreviated as a “COP.” COP-1 took place in Berlin in 1995, and COP-18 just took place in Doha, Qatar, in December 2012.

GAZETTE: What is your role at these conferences?

STAVINS: My role is typically on behalf of the Harvard Project on Climate Agreements. Our purpose is to help the various national negotiating teams identify modes of international cooperation that will address climate change in ways that are scientifically sound, economically rational, and politically pragmatic.

We hold events to which everyone is invited, two events this time. One of the mandates that came out of the Durban conference in December 2012 was for the delegates to think about new ways they can make use of the market to address the threat of climate change. We put together a panel of people to talk about potential “new market mechanisms.” We had a room with a capacity of several hundred, and every seat was taken. People were standing in the aisles, sitting on the floors, and spilling out into the hallway waiting to get in. In other words, interest in our intellectual contributions was at a high level. Importantly, the session was jointly sponsored with the Enel Foundation and the International Emissions Trading Association, which is a trade association of companies interested in emissions trading and related mechanisms.

The second event was co-sponsored with the government of the State of Qatar, and looked forward, post-Doha, to the potential paths ahead, with particular focus on the problems of arid countries, a chronic issue for the Middle East. The panel included Fahad Bin Mohammed Al-Attiya, chairman of the Qatar National Food Security Programme, who is one of the key thinkers and leaders on these issues.

In addition, we carry out bilateral meetings with negotiating teams and also do press meetings. Typically, we hold a couple dozen such meetings.

GAZETTE: How do you feel the conference went?

STAVINS: My view is that these international negotiations need to be viewed not as a sprint, in which you win or lose, but as a very long distance relay race, and the Qataris succeeded in handing off the baton.

The Qataris invited us to Doha last summer to help them begin to think about what success at the December conference would look like and how they could achieve it. There were three aspects to what we identified in advance as success, and they achieved all three, though maybe not to the degree or in the way that every country in the world would have preferred.

GAZETTE: What were those three?

STAVINS: First, they successfully brought to a close negotiations on a second commitment of the Kyoto Protocol, that is, extending the protocol beyond its first commitment period, which expires at the end of 2012. The second commitment period is now set. It will run to 2020. Second, they also brought to a successful close negotiations in what was called the Long Term Cooperative Action track, which included a set of issues that were put on the table at COP-13 in Bali in December 2007. Third, they began to make some progress on the one remaining negotiating track, which is the Durban Platform for Enhanced Action. They initiated discussions about establishing, by 2015, a comprehensive new international agreement, for implementation by 2020, that will include all key countries in the world, including the major emerging economies of China, India, Brazil, Korea, South Africa, and Mexico. That itself is a departure from the Kyoto Protocol, which is focused exclusively on a subset of countries of what used to be characterized as the industrialized world.

The negotiators from around the world did not make as much progress on the Durban platform as I would have hoped. But at a very minimum they did no harm, and that’s very important. That is, they did not introduce any problematic text into the negotiations that will later cause problems. In general, my view of these annual Conferences of the Parties is similar to the physician’s Hippocratic Oath: Do no harm, and keep things moving ahead.

GAZETTE: In looking at news coverage, I read about two emotions, anger and despair, felt by some after the conference. Are those warranted?

STAVINS: AOSIS [Alliance of Small Island States] nations are the most extreme in their point of view, for very good reasons, and they were surely disappointed by the outcomes. They’ve been very vocal, again for good reason. But the major emitters, the only ones that can do anything about the problem — the United States, China, the other large economies of the world, among them — there was recognition that in the real world, this is what success looks like.

I think of this as if we’re back at Bretton Woods in 1944, when Europe was in shambles. An agreement was reached at Bretton Woods, but it took 50 years to establish the World Trade Organization, and to continue the process of putting the global financial house in order. The problem of global climate change is actually more difficult politically than the economic problems that the world faced after World War II. We have this terrible situation where those who can reduce their emissions now are not the ones who will be damaged by climate change. You’re asking current voters to foot the bill, while it’s the future generation that will benefit from reduced damage. Furthermore, any country taking action will foot the bill for its costs, but the benefits of those actions — reduced climate change — will be spread globally. Hence, for any individual country the direct benefits of action will inevitably be less than the direct costs of action, despite the fact that global benefits may be considerably greater than global costs. That’s the global commons problem, and it creates an incentive for each country to free ride on the actions of others. So politically, it’s an exceptionally challenging problem.

GAZETTE: What about the gap between the emissions cuts that were promised and that have been achieved?

STAVINS: What became clear to me at the conference is that there is increasing acceptance of three facts from a broad set of delegations. One was that the frequently discussed target of limiting concentrations to 450 parts per million [of CO₂ in the atmosphere], which is equated to approximately 2 degrees centigrade maximum warming, is simply not achievable.

Number two, there’s increasing recognition that a bottom-up international policy architecture is probably the future path forward, not a top-down approach. By top down, I mean a highly centralized approach like the Kyoto Protocol, with targets and timetables, as opposed to a bottom-up, pledge-and-review approach in which each country essentially says, “Look, this is what I can do,” and they put all of those into the hopper.

The third thing I observed was that there was greatly increased acceptance of the reality that market–based approaches to emissions reduction are absolutely essential. One heard this in the past from economists and from certain countries, but now it is unanimous, except for the small set of Marxist economies that essentially object to the world economic order.

GAZETTE: Where does the U.S. stand on that issue?

STAVINS: The U.S. has been at the forefront of that approach back to the Clinton administration. What’s interesting is that the official U.S. commitment under this pledge-and-review approach, a 17 percent reduction below 2005 emissions by the year 2020, is very likely to be achieved.

The reason is the combination of CO₂ regulations which are now in place because of the Supreme Court decision [freeing the EPA to treat CO₂ like other pollutants under the Clean Air Act], together with five other regulations or rules on SOX [sulfur compounds], NOX [nitrogen compounds], coal fly ash, particulates, and cooling water withdrawals. All of those will have profound effects on retirement of existing coal-fired electrical generation capacity, investment in new coal, and dispatch of such electricity. Combined with that is California, which Jan. 1, 2013, is putting in place a CO₂ cap-and-trade system that is more ambitious in percentage terms than Waxman-Markey was in the U.S. Congress. Add to that the recent economic recession, which reduced emissions. And more important than any of those is what new, unconventional sources of natural gas in the United States have done to the price and price trajectory of natural gas, and the dramatic movement from coal to natural gas for generating electricity.

GAZETTE: Are there things that places like Harvard can do?

STAVINS: My view is that the best thing that Harvard can do is to carry out first-rate research, combined with the best possible teaching, and effective outreach to the public sector and the private sector. That’s our comparative advantage. In other words, our greatest impacts on the environment, including with regard to global climate change, will be through our products (research findings, smart and capable alumni, and direct impact on the policy world and private industry), not our processes. The emissions reductions that Harvard will achieve as a result of changing our carbon footprint, for example, whether it’s through increased energy efficiency of some buildings or some other means, are absolutely trivial compared with our impacts on the world [through teaching, research, and outreach]. And all of us — students, faculty, and administrators — have only so much time available. A very important concept in economics is “opportunity cost,” and there’s an important opportunity cost of a faculty member’s time, for example. If they’re working on one thing, they can’t be working on something else.

GAZETTE: Isn’t there kind of a living-laboratory aspect to what we’re doing?

STAVINS: I agree with that. So the one caveat — which I always mention — to what I said would be if direct actions by the University to limit emissions or energy demand were part and parcel of a research initiative or part and parcel of teaching, then those would be part of our core functions.

GAZETTE: Does that extend to the conversation on divestment?

STAVINS: I guess the way in which it links to that issue is whether or not symbolic actions are of value, but again you have to weigh symbolic actions against truly meaningful actions.

GAZETTE: What’s the most important thing for a member of the public to know about the climate talks and about climate change generally?

STAVINS: I think the most important thing to understand is that this is a long-term problem. Economically, a cost-effective approach is going to be very gradual reductions in emissions, not sudden changes. We’re not confiscating everyone’s automobiles tomorrow, but putting in place incentives or regulations so that next time they buy an automobile they move in the right direction, one that is less carbon intensive.

A massive amount of technology change is going to be required. That’s long term, and the creation of durable international institutions is going to be necessary, and that’s long term. That’s why that cliché we always hear from ballplayers each spring when they’ve lost their first 10 games — that it’s a marathon, not a sprint — applies even more to global climate change policy.

People should get neither excited nor depressed, in my view, over one single negotiation. It’s an ongoing process that’s going to be with us for a long time.

GAZETTE: Are you confident that ultimately what needs to happen will happen?

STAVINS: I’m not sure that it will happen through a centralized, top-down, international agreement. Nor am I even certain that the core of the action will be through international negotiations. Remember, 20 countries and regions account for about 90 percent of emissions. So there are alternative venues where meaningful action can happen without requiring agreement from 195 countries! One way or another, — through national action, bilateral action, multilateral action — things will be addressed. That doesn’t mean they will be addressed without the world first experiencing significant climate change damages.

Cap-and-Trade, Carbon Taxes, and My Neighbor’s Lovely Lawn

The recent demise of serious political consideration of an economy-wide U.S. CO₂ cap-and-trade system and the even more recent resurgence in interest among policy wonks in a U.S. carbon tax should prompt reflection on where we’ve been, where we are, and where we may be going.

Lessons

Almost fifteen years ago, in an article that appeared in 1998 in the Journal of Economic Perspectives, “What Can We Learn from the Grand Policy Experiment? Lessons from SO₂ Allowance Trading,” I examined the implications of what was then the very new emissions trading program set up by the Clean Air Act Amendments of 1990 to cut acid rain by half over the succeeding decade. In that article, I attempted to offer some guidance regarding the conditions under which cap-and-trade (then known as “tradable permits”) was likely to work well, or not so well. Here’s a brief summary of what I wrote at the time:

(1) SO₂ trading was a case where the cost of abating pollution differed widely among sources, and where a market-based system was therefore likely to have greater gains, relative to conventional, command-and-control regulations (Newell and Stavins 2003). It was clear early on that SO₂ abatement cost heterogeneity was great, because of differences in ages of plants and their proximity to sources of low-sulfur coal. But where abatement costs are more uniform across sources, the political costs of enacting an allowance trading approach are less likely to be justifiable.

(2) The greater the degree to which pollutants mix in the receiving airshed or watershed, the more attractive a cap-and-trade (or emission tax) system will be, relative to a conventional uniform standard. This is because taxes or cap-and-trade can – in principle – lead to localized “hot spots” with relatively high levels of ambient pollution. Some states (in particular, New York) tried unsuccessfully to erect barriers to trades they thought might increase deposition within their borders. This is a significant distributional issue. It can also be an efficiency issue if damages are nonlinearly related to pollutant concentrations.

(3) The efficiency of a cap-and-trade system will depend on the pattern of costs and benefits. If uncertainty about marginal abatement costs is significant, and if marginal abatement costs are quite flat and marginal benefits of abatement fall relatively quickly, then a quantity instrument, such as cap-and-trade, will be more efficient than a price instrument, such as an emission tax (Weitzman 1974). With a stock pollutant (such as CO₂), this argument favors a price instrument (Newell and Pizer 2003). However, when there is also uncertainty about marginal benefits, and marginal benefits are positively correlated with marginal costs (which, it turns out, is a relatively common occurrence for a variety of pollution problems), then there is an additional argument in favor of the relative efficiency of quantity instruments (Stavins 1996).

(4) Cap-and-trade will work best when transaction costs are low (Stavins 1995), and the S0₂ experiment showed that if properly designed, private markets will tend to render transaction costs minimal.

5) Considerations of political feasibility point to the wisdom of proposing trading instruments when they can be used to facilitate emissions reductions, as was done with SO₂ allowances and lead rights trading, less so for the purpose of reallocating existing emissions abatement responsibility (Revesz and Stavins 2007).

(6) National policy instruments that appear impeccable from the vantage point of Cambridge, Massachusetts, Berkeley, California, or Madison, Wisconsin, but consistently prove infeasible in Washington, D.C., can hardly be considered “optimal.”

Implications for CO₂ Policy

In the same article, I noted that many of these issues could be illuminated by considering a concrete example: the “current interest” in applying cap-and-trade to the task of cutting CO₂ emissions to reduce the risk of global climate change. Some of the points I made in this regard in my 1998 article were:

(a) The number of sources of CO₂ emissions are vastly greater than in the case of SO₂ emissions as a precursor of acid rain, where the focus could be placed on a few hundred electric utility plants. Feasibility considerations alone argue for market-based instruments (cap-and-trade or taxes) to achieve meaningful reductions of CO₂ emissions.

(b) The diversity of sources of CO₂ in a modern economy and the consequent heterogeneity of emission reduction costs bolster the case for using cost-effective market-based instruments.

(c) As the ultimate global-commons problem, CO₂ is a truly uniformly-mixed pollutant. With no concern for hot spots, market-based instruments present none of the problems that can arise in the case of localized environmental threats.

(d) Any pollution-control program must face the possibility of emissions leakage from regulated to unregulated sources. This would be a severe problem for an international CO₂ program, where emissions would tend to increase in nonparticipant countries. Furthermore, it raises concerns for the emission-reduction-credit (not cap-and-trade) system in the Kyoto Protocol known as the Clean Development Mechanism (CDM). Such an offset system can lower aggregate costs by substituting low-cost for high-cost control, but may also have the unintended effect of increasing aggregate emissions beyond what they would otherwise have been, because there is an incentive for adverse selection: sources in developing countries that would reduce their emissions, opt in, and receive credit for actions they would have taken anyway.

(e) Although any trading program could potentially serve as a model for the case of global climate change, I argued that the trading system that accomplished the U.S. phaseout of leaded gasoline in the 1980s merited particular attention. The currency of that system was not lead oxide emissions from motor vehicles, but the lead content of gasoline. So too, in the case of global climate, great savings in monitoring and enforcement costs could be had by adopting input trading linked with the carbon content of fossil fuels. This is reasonable in the climate case, since – unlike in the SO₂ case – CO₂ emissions are roughly proportional to the carbon content of fossil fuels and scrubbing alternatives are largely unavailable, at least at present.

(f) Natural sequestration of CO₂ from the atmosphere by expanding forested areas is available (even in the United States) at reasonable cost (Stavins 1999). Hence, it could be valuable to combine any carbon trading (or carbon tax) program with a carbon sequestration program, although this will raise significant challenges in regard to monitoring and enforcement.

(g) In regard to carbon permit allocation mechanisms, auctions would have the advantage that revenues could be used to finance reductions in distortionary taxes. Free allocation could increase regulatory costs enough that the sign of the efficiency impact could conceivably be reversed from positive to negative net benefits (Parry, Williams, and Goulder 1999). On the other hand, free allocation of carbon permits would meet with much less political resistance.

The Necessity of Market-Based Instruments: Cap-and-Trade or Carbon Taxes

I concluded that developing a cap-and-trade system for climate change would bring forth an entirely new set of economic, political, and institutional challenges. At the same time, I recognized that the diversity of sources of CO₂ emissions and the magnitude of likely abatement costs made it equally clear that only a market-based instrument – some form of carbon rights trading or (probably revenue-neutral) carbon taxes – would be capable of achieving the domestic targets that might eventually be forthcoming.

In other words, my conclusion in 1998 strongly favored a market-based carbon policy, but was somewhat neutral between carbon taxes and cap-and-trade. Indeed, at that time and for the subsequent eight years or so, I remained agnostic regarding what I viewed as the trade-offs between cap-and-trade and carbon taxes. What happened to change that? Three words: The Hamilton Project.

The Making of an Advocate

For those of you who don’t know, the Hamilton Project is an initiative based at the Brookings Institution that – according to its web site – “offers a strategic vision and produces innovative policy proposals on how to create a growing economy that benefits more Americans.”

In 2007, the Project’s leadership asked me to write a paper proposing a U.S. CO₂ cap-and-trade system. I responded that I would prefer to write a paper proposing the use of a market-based CO₂ policy, describing the two alternatives of cap-and-trade and carbon taxes. I explained that I was by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years. Indeed, I noted, both cap-and-trade and carbon taxes would be good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences.

The Hamilton Project leaders said no, they wanted me to make the best case I could for cap-and-trade, not a balanced investigation of the two policy instruments. Someone else would be commissioned to write a proposal for a carbon tax. (That turned out to be Professor Gilbert Metcalf of Tufts University – now on leave at the U.S. Department of the Treasury – who did a splendid job!) Thus, I was made into an advocate for cap-and-trade. It’s as simple as that.

Giving It My Best Shot

I argued in my Hamilton Project paper (which you can read here) that despite the tradeoffs between the two principal market-based instruments that could target CO₂ emissions, the best (and most likely) approach for the short to medium term in the United States was a cap-and-trade system, based on three criteria: environmental effectiveness, cost effectiveness, and distributional equity. Although my position was not simple capitulation to politics, I argued that sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should be made in a real-world political context.

I said that the key merits of the cap-and-trade approach were, first, the program could provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels. Second, it offered an easy means of compensating for the inevitably unequal burdens imposed by a climate policy. Third, it provided a straightforward means to link with other countries’ climate policies. Fourth, it avoided the political aversion in the United States to taxes. Fifth, it was unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach had a history of successful adoption and implementation in this country over the past two decades.

I recognized that there were some real differences between taxes and cap-and-trade that needed to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provide greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly cost-containment mechanisms. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and is why virtually no environmental NGOs have favored the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of the free allowances, which affect distribution, but not environmental effectiveness, and not cost-effectiveness.

I concluded that proponents of carbon taxes worried about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax would be sensitive to the same political pressures, and should be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

Of course, such positive political economy arguments look much less compelling in the wake of the defeat of cap-and-trade legislation in the U.S. Congress and its successful demonization by conservatives as “cap-and-tax.”

A Political Opening for Carbon Taxes?

Does the defeat of cap-and-trade in the U.S. Congress, the obvious unwillingness of the Obama White House to utter the phrase in public, and the outspoken opposition to cap-and-trade by Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO₂ emissions reductions?

First of all, there surely is such an opening in the policy wonk world. Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax. And a much-publicized meeting in July at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy. Reportedly, much of the discussion focused on carbon taxes.

Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world. But what about in the real political world? The good news is that a carbon tax is not “cap-and-trade.” That presumably helps with the political messaging! But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax! Also, note that Romney’s stated opposition and Obama’s silence extend beyond disdain for cap-and-trade per se. Rather, they cover all carbon-pricing regimes.

So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington, no matter what the outcome of the election. Note that the only election outcome that could lead to an aggressive and successful move to a meaningful nationwide carbon pricing regime would be: the Democrats take back control of the House of Representatives, and the Democrats achieve a 60+ vote margin in the Senate, and the President is reelected. A quick check at Five Thirty Eight (Nate Silver’s superb election forecast website at the New York Times) and other polling web sites makes it abundantly clear that the probability of such Democratic control of the White House and Congress is so small that it’s hardly worth discussing.

What About Fiscal Policy Reform?

A more promising possibility – though still unlikely – is that if Republicans and Democrats join to cooperate with either a Romney or Obama White House to work together constructively to address not only the short-term fiscal cliff at the end of this calendar year, but also the longer-term budgetary deficits the U.S. government faces, and if as part of this they decide to include not only cuts in government expenditures, but also some significant “revenue enhancements” (the t-word is not allowed), and if (I know, this is getting to be a lot of “if’s”) it turns out to be easier politically to eschew increases in taxes on labor and investment and therefore turn to taxes on consumption, then there could be a political opening for new energy taxes, in particular, (drum roll ….) a carbon tax.

Such a carbon tax – if intended to help alleviate budget deficits – could not be the economist’s favorite, a revenue-neutral tax swap of cutting distortionary taxes in exchange for implementing a carbon tax. Rather, as a revenue-raising mechanism – like the Obama administration’s February 2009 budget for a 100%-auction of allowances in a cap-and-trade scheme – it would be a new tax, pure and simple. Those who recall the 1993 failure of the Clinton administration’s BTU-tax proposal – with a less polarized and more cooperative Congress than today’s – are not optimistic.

Nor is it clear that a carbon tax would enjoy more support in budget talks than a value added tax (VAT) or a Federal sales tax. The key question is whether the phrases “climate policy” or “carbon tax” are likely to expand or narrow the coalition of support for an already tough budgetary reconciliation measure. The key group to bring on board will presumably be conservative Tea Party Republicans, and it is difficult to picture them being more willing to break their Grover Norquist pledges because it’s for a carbon tax.

Research

Even if the much-ballyhooed political opening for carbon taxes is largely illusory, the opening for policy wonks is real. And here is where action is happening, and should continue to happen. At some point the politics will change, and it’s important to be ready. This is why economic research on carbon taxes is very much needed, particularly in the context of broader fiscal challenges, and it is why I’m pleased to see it happening at Resources for the Future, Harvard University, and elsewhere.

Bottom Line

I would personally be delighted if a carbon tax were politically feasible in the United States, or were to become politically feasible in the future. But I’m forced to conclude that much of the current enthusiasm about carbon taxes in the academic and broader policy-wonk community in the wake of the defeat of cap-and-trade is – for the time being, at least – largely a manifestation of the grass looking greener across the street.

Can Market Forces Really be Employed to Address Climate Change?

Debate continues in the United States, Europe, and throughout the world about whether the forces of the marketplace can be harnessed in the interest of environmental protection, in particular, to address the threat of global climate change. In an essay that appears in the Spring 2012 issue of Daedalus, the journal of the American Academy of Arts and Sciences, my colleague, Joseph Aldy, and I take on this question. In the article – “Using the Market to Address Climate Change: Insights from Theory & Experience” – we investigate the technical, economic, and political feasibility of market-based climate policies, and examine alternative designs of carbon taxes, cap-and-trade, and clean energy standards.

The Premise

Virtually all aspects of economic activity – individual consumption, business investment, and government spending – affect greenhouse gas emissions and, therefore, the global climate. In essence, an effective climate change policy must change the nature of decisions regarding these activities in order to promote more efficient generation and use of energy, lower carbon-intensity of energy, and a more carbon-lean economy.

Basically, there are three possible ways to accomplish this: (1) mandate that businesses and individuals change their behavior; (2) subsidize business and individual investment; or (3) price the greenhouse gas externality proportional to the harms that these emissions cause.

Harnessing Market Forces by Pricing Externalities

The pricing of externalities can promote cost-effective abatement, deliver efficient innovation incentives, avoid picking technology winners, and ameliorate, not exacerbate, government fiscal conditions.

By pricing carbon emissions (or, equivalently, the carbon content of the three fossil fuels – coal, petroleum, and natural gas), the government provides incentives for firms and individuals to identify and exploit the lowest-cost ways to reduce emissions and to invest in the development of new technologies, processes, and ideas that can mitigate future emissions. A fairly wide variety of policy approaches fall within the concept of externality pricing in the climate-policy context, including carbon taxes, cap-and-trade, and clean energy standards.

What About Conventional Regulatory Approaches?

In contrast, conventional approaches to environmental protection typically employ uniform mandates to protect environmental quality. Although uniform technology and performance standards have been effective in achieving some established environmental goals and standards, they tend to lead to non-cost-effective outcomes in which some firms use unduly expensive means to control pollution.

In addition, conventional technology or performance standards do not provide dynamic incentives for the development, adoption, and diffusion of environmentally and economically superior control technologies. Once a firm satisfies a performance standard, it has little incentive to develop or adopt cleaner technology. Indeed, regulated firms may fear that if they adopt a superior technology, the government will tighten the standard.

Given the ubiquitous nature of greenhouse gas emissions from diverse sources, it is virtually inconceivable that a standards-based approach could form the centerpiece of a truly meaningful climate policy. The substantially higher cost of a standards-based policy may undermine support for such an approach, and securing political support may require weakening standards and lowering environmental benefits.

How About Technology Subsidies?

Government support for lower-emitting technologies often takes the form of investment or performance subsidies. Providing subsidies for targeting climate-friendly technologies entails revenues raised by taxing other economic activities. Given the tight fiscal environment throughout the developed world, it is difficult to justify increasing (or even continuing) the subsidies that would be necessary to change significantly the emissions intensity of economic activity.

Furthermore, by lowering the cost of energy, climate-oriented technology subsidies can actually lead to excessive levels of energy supply and consumption. Thus, subsidies can undermine incentives for efficiency and conservation, and impose higher costs per ton abated than cost-effective policy alternatives.

In practice, subsidies are typically designed to be technology specific. By designating technology winners, such approaches yield special-interest constituencies focused on maintaining subsidies beyond what would be socially desirable. They also provide little incentive for the development of novel, game-changing technologies.

That said, there is still a role for direct technology policies in combination with externality pricing, as I have argued in a previous essay at this blog. This is because in addition to the environmental market failure (appropriately addressed by externality pricing) there exists another market failure in the climate change context, namely, the public-good nature of information produced by research and development. I addressed this in my essay, “Both Are Necessary, But Neither is Sufficient: Carbon-Pricing and Technology R&D Initiatives in a Meaningful National Climate Policy.”

Back to Markets, and Some Real-World Experience

Empirical analysis drawing on actual experience has demonstrated the power of markets to drive profound changes in the investment and use of emission-intensive technologies.

The run-up in gasoline prices in 2008 increased consumer demand for more fuel-efficient new cars and trucks, while also reducing vehicle miles traveled by the existing fleet. Likewise, electricity generators responded to the dramatic decline in natural gas prices in 2009 and 2010 by dispatching more electricity from gas plants, resulting in lower CO₂ emissions.

Longer-term evaluations of the impacts of energy prices on markets have found that higher prices have induced more innovation – measured by frequency and importance of patents – and increased the commercial availability of more energy-efficient products, especially among energy-intensive goods such as air conditioners and water heaters.

Experience with Externality Pricing

Real-world experience with policies that price externalities has illustrated the effectiveness of market-based instruments. Congestion charges in London, Singapore, and Stockholm have reduced traffic congestion in busy urban centers, lowered air pollution, and delivered net social benefits. Likewise, the British Columbia carbon tax has reduced carbon dioxide emissions since 2008.

More prominently, the U.S. sulfur dioxide (SO₂) cap-and-trade program has cut SO₂ emissions from U.S. power plants by more than 50 percent since 1990, resulting in compliance costs one-half of what they would have been under conventional regulatory mandates.

The success of the SO₂ allowance trading program motivated the design and implementation of the European Union’s Emissions Trading Scheme (EU ETS), the world’s largest cap-and-trade program, focused on cutting CO₂ emissions from power plants and large manufacturing facilities throughout Europe.

And the 1980s phasedown of lead in gasoline, which reduced the lead content per gallon of fuel, served as an early, effective example of a tradable performance standard.

These positive experiences have provided ample reason to consider market-based instruments – carbon taxes, cap-and-trade, and clean energy standards – as potential approaches to mitigating greenhouse gas emissions.

The Rubber Hits the Road

The U.S. political response to possible market-based approaches to climate policy has been and will continue to be largely a function of issues and structural factors that transcend the scope of environmental and climate policy. Because a truly meaningful climate policy – whether market-based or conventional in design – will have significant impacts on economic activity in a wide variety of sectors and in every region of the country, it is not surprising that proposals for such policies bring forth significant opposition, particularly during difficult economic times.

In addition, U.S. political polarization – which began some four decades ago and accelerated during the economic downturn – has decimated what had long been the key political constituency in Congress for environmental (and energy) action: namely, the middle, including both moderate Republicans and moderate Democrats. Whereas congressional debates about environmental and energy policy have long featured regional politics, they are now largely partisan. In this political maelstrom, the failure of cap-and-trade climate policy in the Senate in 2010 was collateral damage in a much larger political war.

Better economic times may reduce the pace – if not the direction – of political polarization. And the ongoing challenge of large federal budgetary deficits may at some point increase the political feasibility of new sources of revenue. When and if this happens, consumption taxes – as opposed to traditional taxes on income and investment – could receive heightened attention; primary among these might be energy taxes, which, depending on their design, can function as significant climate policy instruments.

Many environmental advocates would respond that a mobilizing event will surely precipitate U.S. climate policy action. But the nature of the climate change problem itself helps explain much of the relative apathy among the U.S. public and suggests that any such mobilizing events may come “too late.”

Nearly all our major environmental laws have been passed in the wake of highly publicized environmental events or “disasters,” including the spontaneous combustion of the Cuyahoga River in Cleveland, Ohio, in 1969, and the discovery of toxic substances at Love Canal in Niagara Falls, New York, in the mid-1970s. But note that the day after the Cuyahoga River caught on fire, no article in The Cleveland Plain Dealer commented that the cause was uncertain, that rivers periodically catch on fire from natural causes. On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries. A direct consequence of the observed “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different. Unlike the environmental threats addressed successfully in past U.S. legislation, climate change is essentially unobservable to the general population. We observe the weather, not the climate. Until there is an obvious and sudden event – such as a loss of part of the Antarctic ice sheet leading to a dramatic sea-level rise – it is unlikely that public opinion in the United States will provide the bottom-up demand for action that inspired previous congressional action on the environment over the past forty years.

A Half-Full Glass of Water?

Despite this rather bleak assessment of the politics of climate change policy in the United States, it is really much too soon to speculate on what the future will hold for the use of market-based policy instruments, whether for climate change or other environmental problems.

On the one hand, it is conceivable that two decades (1988–2008) of high receptivity in U.S. politics to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation.

On the other hand, it is also possible that the recent tarnishing of cap-and-trade in national political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments. Perhaps the ongoing interest in these policy mechanisms in California (Assembly Bill 32), the Northeast (Regional Greenhouse Gas Initiative), Europe, and other countries will eventually provide a bridge to a changed political climate in Washington.