In the first of Reihan’s recent posts about carbon pricing, he mentions the inimitable Jim Manzi’s writing on the subject, saying that Jim has “already made the case against cap and trade pretty effectively.” Now, unless I missed something, Jim has actually made two different points, both of which I agree with:
Pursuing market-based solutions to carbon mitigation means choosing either a quantity instrument (cap and trade) or a price instrument (a carbon tax). Jim’s convinced me that there is no workable price instrument at our disposal, leaving us with cap-and-trade as the only remaining option. Just because it’s the other option presented doesn’t make it right, but nor does the fact that politicians like cap and trade make it the worst idea in the world. A cap and trade program with all the necessary bells and whistles (an initial auction, a liquid market, tradability, bankability, etc.) would be a simpler and more transparent way to reduce aggregate US CO2 emissions if that’s what we decide to do.
The precedent for a tradable permit system, of course, is the successful SO2 allowance trading program implemented in the 1990 Clean Air Act amendments. This ten year-old paper discusses the lessons to be learned from “the Grand Policy Experiment,” as it’s described, and mentions a few points that apply to any market-based carbon mitigation policy. A few aspects of the CO2 problem argue in favor of a quantity instrument:
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 tradeable permits, will be more efficient than a price instrument, such as an emission tax (Weitzman, 1974). Furthermore, when there is 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.
If there were ever a case of “uncertainty about marginal benefits,” carbon mitigation is it. Avoiding one ton of CO2 emissions today doesn’t deliver benefits for generations hence, and then only if it’s part of a massive global reduction.
A legislative mandate to reduce the US’s greenhouse gas emissions to some politically determined ceiling, for all its arbitrariness, is more rational than convincing ourselves that we’ve magically identified the social costs of each ton of CO2 and “priced the externality.” Reihan is right that the US’s incremental reduction isn’t nearly enough to reduce warming by the IPCC’s preferred 50-85%, and our “setting an example” is unlikely to make a difference in the carbon intensity of developing nations’ economies.
I remain unconvinced that it’s possible to mitigate climate change with any tools at our disposal, and I don’t think we’ll bring the next generation of energy sources to market by making fossil fuels more expensive in relative terms. Such an approach is especially fragile in an inflationary and increasingly zero-sum world economy, so I tend to agree with Indur Goklany and Tom Schelling that the best way to solve the problem of climate change is by applying the brainpower that only a wealthier developing world can deliver. The political consensus, however, is for getting a head start on direct mitigation, and emissions trading might be the least-bad way to do so.