A Sustainable Climate Policy

In the wake of Typhoon Haiyan, one of the strongest to ever make landfall, the Philippine delegate to the climate talks in Warsaw made a desperate plea for nations to act on climate change. President Aquino when asked by CNN’s Christiane Amanpour whether he believed the warming of the planet had a direct link to the severe weather event affirmed the position. British Prime Minister David Cameron made a similar statement.

The Inter-governmental Panel on Climate Change says that severe weather events will be the consequence if carbon pollution is not abated. And yet what we find is advanced countries like Australia, Canada andJapan, that are all led by conservative governments, back-tracking or weakening their stance on the issue. 

Governments around the world from Beijing to Washington are grappling with the problem to avoid what economists call “the tragedy of the commons”. This is a situation where when a certain market activity has a negative by-product (such as emitting GHG into the atmosphere) and people are free to do (no cost is attached to it), then it will be engaged in excessively to the detriment of all. The only way to avoid this outcome is to make economic agents absorb the cost associated with abating the negative by-product.

The question that policymakers worldwide are grappling with is who should absorb the cost and what mechanisms are needed to make them absorb it? A carbon tax gives residents the right to free air and imposes the cost of abatement on the polluter. The problem is that polluters will then pass on the cost on to consumers.  An alternative would be to pay polluters to stop polluting using taxpayer’s money.

From an economic perspective, it does not matter which mechanism is used as long as no one has the ability to "game" or influence the system. From a political point of view, however, framing the policy as a tax or incentive may have enormous consequences as the Australian Labor Party painfully realised in the last election.

Beyond the theatre and drama of the climate change debate, the political players have to find some kind of common ground, though to make whichever solution is opted for credible and sustainable. One prime example of this is the climate change policy adopted by British Columbia (BC), which has been in place since 2008 and whose popularity remains intact and has even increased.

It involves a tax that puts a price on carbon that is returned to citizens and businesses through reduced income taxes and increased tax credits or benefits. The tax is broad based covering the use of fossil fuels for electricity and vehicles. The policy has reduced the consumption of taxed fuels per capita by 19 per cent in the BC relative to the rest of Canada. GHG emissions in the province fell 10 per cent between 2008 and 2011, compared to a fall of 1.1 per cent for the rest of Canada.

The carbon tax was originally set at C$10 per tonne of carbon dioxide equivalent emissions and was increased by C$5 each year until it reached C$30 in 2012, when it was subject to a review and fixed following the release of a report in 2013. The report suggested that the tax did not seem to have an impact on BC’s economy, although certain sectors such as the agri-food and agriculture sector needed additional relief, which is forthcoming.

The success of BC’s climate change policy matches that of Quebec and California, which introduced a cap on GHG and an emissions trading scheme. BC and other North American states in the Pacific coast, Oregon and Washington have been encouraged to set up similar schemes and to link their systems together. They could soon be joined by provinces along the coast of China. China is working to develop a nationwide approach after 2015.

Getting to a harmonised global scheme is quite challenging, but not impossible as the efforts of some of these jurisdictions are showing. 

Reframing the Climate Debate

The Climate debate has proven to be a diabolical policy problem for politicians in Australia, a country with one of the highest carbon dioxide emissions per capita in the world having an economy heavily dependent on the export of coal and other carbon intensive commodities.

It was partly responsible for the sacking of a once popular PM by members of his own party during his first term. It was dragging down the popularity of the lady that replaced him. Even a coalition between the Greens, Labor and a few independents representing country-based electorates could not provide a consensus in the debate.

Then came the proposal of an economist to offset a carbon tax with an income tax cut. The idea is hardly new. Even the Prophet of an Inconvenient Truth advised the scrapping of payroll taxes in lieu of a carbon tax a few years ago. The idea was to lighten the burden of productive activity (labor) while increasing it for environmentally destructive ones (pollution).

The advocacy of this tax cut approach as part of an overall principle of making the polluter pay while compensating vulnerable members of the community has stemmed the bleeding of support as expressed in the poll numbers and restored this government's legitimacy at least for now.

The re-framing of the debate is something that has eluded previous proposals for a carbon pollution reduction scheme. The use of a tax to price carbon rather than a synthetic market (read: emissions trading scheme) is much simpler and straight-forward. It also avoids much of the costly transactions costs involved in setting a complex trading system.

The use of tax cuts to offset additional living costs on households to whom polluting energy firms would pass on any tax burden does away with the notion that the "little man" would be the hardest hit by the tax. It also reduces the disincentive to work without creating budget pressures.

Indeed the Opposition will wish that it had proposed the Carbon tax with the accompanying income tax cuts ahead of the government as what a conservative think tank had earlier done. Having been outflanked by Labor on this issue, it now has to reconcile its carbon abatement policies which opts to use government regulation rather than a market mechanism something that economic liberals are not known for. Being the party that invented "middle class welfare" it will now find it difficult to counteract the middle and lower income tax cuts now being considered.

The Ecological "Arc" of the World Economy

The following entry contains nothing new about carbon emissions that hasn't already been picked up by the media; instead, it seeks to present the facts differently. 

The map below shows the total size of CO-2 emissions over five decades where each bubble represents total emissions by a country. If you hit the play button, you will see the gradual growth of emissions over time. Quite striking is the rise of China over the past decade dislodging the US as the biggest emitter with 6 million kilo tons (kt) of emissions compared to 5.7M for the US. Russia and India follow suit with about 1.5M kt each, and Japan ranks fifth with 1.3M kt.

The next chart plots the CO-2 emissions per capita of each country along the vertical axis with  average incomes (gross national income per capita) on the horizontal axis based on purchasing power parity (or PPP) measuring income in terms of what citizens can afford based on the cost of goods and services relative to wages. The bubbles represent the population size of each country.

One sees clearly an "arc" that gradually slopes upwards such that as countries get richer, each citizen consumes more resources and generates more pollution. From 1980, this arc gradually moves rightwards reflecting technological advances that have made industries more efficient in their use of resources, i.e. it takes less carbon to produce a dollar's worth of goods. In 1980, the point at which emissions per capita started to rise was at $1,000. In 2006, it was close to $4,000.

For the world economy to grow in a sustainable way, rapid technology development is needed to make production less reliant on carbon so that as poorer countries move up the income scale, they do not cause environmental damage at a rate similar to that of rich countries in the past. The arc needs to be flattened and pushed rightwards. It is not viable to prevent the rise of affluence in poorer nations as poverty tends to be correlated with faster population growth.

China with its 1.3 billion people earning $4,700 on average is already on the upward sloping part of the arc. Displacement of industries from rich countries that have stringent environmental policies is largely responsible. Egypt which has about the same level of income per person as China, emits 3-kt per capita compared to China's 5-kt reflecting a different mix of industries. India with an average income of $2,500 per person still lies on the flat portion of the arc and has a relatively low carbon footprint of 1-kt.

For the arc to flatten and shift rightwards, incentives are needed to encourage investments in new technology that will shift production away from carbon intensive methods and into cleaner ones. The rate of technological progress has to be faster than economic progress of poorer nations. The arc has to be bent downwards faster to accommodate the bigger but poorer nations who are "catching up" with the smaller but richer ones. If not, the future well-being of all those who live on the arc could be at-risk. 

For a discussion on the history of the science behind global warming, I found the following source quite illuminating: http://www.aip.org/history/climate/ from the American Institute of Physics.