One of the big bones of contention in the “what to do about global warming” debate is whether to use carbon taxes or carbon trading to reduce greenhouse gas emissions. In theory, either regime could produce a satisfactory result, and many commentators prefer carbon trading, out of what amounts to an ideological bias in favor of markets and against taxation. Even Harvard economics advisor Greg Mankiw (former chairman of the Council of Economics Advisers under Bush II) prefers carbon taxes because they deliver results with more certainty.
We have been skeptical of carbon trading for two reasons. First, having worked in markets, we know how easily they can be manipulated, and this one has characteristics that would allow for abusive practices (the big one being information asymmetries: the dealers will know vastly more about market conditions. You don’t have a framework that allows buyers and sellers to meet on an equal footing). Second, the price of carbon under a trading system will be volatile, and as the Financial Times noted in an editorial, what corporations and investors need is a “clear and predictable” price for carbon, so they can cost out alternatives and make sensible plans and investments. Third, carbon trading is likely to involve higher costs than a tax regime (dealer infrastructure and dealer profits have to be paid for somehow, while the marginal cost of adding and complying with a new tax would not be high.).
The BBC, in its story, “Carbon trade scheme ‘is failing’” confirms our suspicions. The article charges that carbon trading created a wealth transfer from consumers, who paid an estimated 7% more due to the regime, to electricity generators, who enjoyed windfall profits.
The Financial Times, in a series of stories analyzing carbon trading, found the same pattern: that companies often got large payments for activities they would have engaged in regardless. They also found widespread fraud.
To the BBC:
The EU’s carbon trading scheme has increased electricity bills, given a windfall to power companies and failed to cut greenhouse gases, it is claimed.
An investigation by BBC Radio 4’s File on 4 programme has found that after two and half years the scheme has yet to cut in carbon dioxide emissions.
The consumer body Energywatch said customers are getting a raw deal.
But a government minister has promised that the scheme’s next phase will be a big improvement.
The EU’s Emission Trading Scheme – a key part of the UK Government’s drive to combat climate change – began in 2005 and created a trade in carbon allowances.
It is essentially a permit to pollute.
Power generators received their allowances free of charge but were allowed to reflect the value of those in increased prices to customers, as if the companies had actually had to buy the allowances.
Energywatch believes this increased electricity bills by about 7% in 2005.
And according to one government estimate, that delivered windfall profits of up to £1.3bn to the generators in that year – higher than environmental campaigners had claimed last year.
However, so far the carbon scheme has brought no clear payback in terms of cutting emissions.
Provisional government figures from the Department for Environment Food and Rural Affairs (DEFRA) suggest CO2 output in Britain actually went up, by 1.25% last year wiping out a slight drop of 0.01% in 2005.
It is also reckoned that CO2 emissions across the EU also rose by between 1 and 1.5% over the last two years.
The chief executive of Energywatch, Allan Asher, said , “Consumers increasingly accept the need for reductions in carbon.
“However they are paying the price and not seeing the benefits. The big generators are banking huge amounts of money and consumers aren’t benefiting.”
But the Minister for Climate Change, Ian Pearson, told File on 4 that the carbon trading scheme has been an administrative success yet concedes there have been problems in the first three year phase to the end of 2007.
“If you are saying to me it hasn’t achieved a massive amount so far when it comes to CO2 reductions, well I agree with you and I think Phase Two will be a big, big improvement…and a key instrument in helping us all to achieve our carbon reduction targets across Europe.”