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. 

Malcolm in the Middle

In the debate over the proposed emissions trading scheme (ETS), beleaguered Federal Opposition leader Malcolm Turnbull seems to be between a rock and a hard place. Two camps seem to be putting the squeeze on him. Each one holding to a specific set of beliefs.

One the one hand, market reformists point to the phenomena known as global warming and climate change as indicative of the need to reform capitalism as we know it. On the other hand, market fundamentalists see the ETS as an intrusion by government into the affairs of the private sector which come with unnecessary distortions and costs to the Australian public. They allege no benefits will accrue unless a global deal is reached in Copenhagen by world leaders.

Proponents on the one hand see the need to internalise the undesirable side effects of productive activity as a way to improve the price signals to production and consumption that currently regard what nature endows as free. The political reality as pointed out by Mr Turnbull is that any attempt to spurn this publicly supported proposal will be met with scorn at the polls.

Opponents from within Malcolm's party see it as a "tax" or as onerous regulation. (It actually has elements of both in the form of a cap which sets limits on emissions--the regulatory part--and a trading scheme for emissions permits which will set a price for carbon--the tax part). They also want additional concessions for emitters although doing so would create additional distortions to the ETS. This amounts to a "free lunch" for emitters according to the Greens who oppose the legislation outright. Without their support, the Federal Opposition finds itself in a bind.

Rejecting the legislation could trigger an early election on the issue of climate change. By arguing in favour of passing the ETS legislation now, Mr Turnbull wants to position the Coalition that he heads safely into the next election as far as this issue is concerned. This has earned him the ire of his partymates who see delaying it as the only viable option.

On the other hand, he is receiving no help from the government which wants to play the symbollic game at the Copenhagen summit or perhaps make do with the self-destruction of the Opposition. Apparently, the middle ground seems to be melting beneath his feet. This "inconvenient truth" seems to be dawning on Malcolm and his supporters.

Poor Incentives

If you were prudent enough to save and invest your money rather than spend and borrow more money, you have probably taken a hit in your shares portfolio and will face rising inflation in the next few years as a double dip recession (a W shaped recovery) takes place, eating away at your cash holdings. The banks that have been rescued and recapitalised using reserve infusions are loath to lend under the current environment and therefore will not raise rates on cash and term deposits even as the reserve rates increase given that they are awash with cash.

If you were a rural bank, saving and loans company or credit union that maintained a healthy balance sheet and avoided risky derivatives, then you were not in line for a government guarantee or a subsidised line of credit during the height of the financial crisis. You instead would have the added burden of competing with larger subsidised commercial banks with AAA credit rating not as a result of their prudential risk taking but as a result of sovereign guarantees. Your employees have probably been faced with pay cuts or no bonuses unlike the corporate executives of the bailed out entities courtesy of taxpayer dollars.

If you are in a business that was deemed “too small to rescue” having been cautious in leveraging your operation and prudent in evaluating expansion projects, then you probably did not receive any cash handouts through the stimulus plan, unlike the relics of some old smokestack age that got heaps of support to remain open. You will probably be facing higher taxes in the coming years as the need to repay the deficits in a slower growth environment forces many governments to raise taxes from “productive” units of the economy.

If you are a relatively low polluting, eco-friendly operation, then you are definitely not going to be in line for a “free” carbon credit courtesy of the government unlike trade exposed carbon intensive industries. You instead are going to have to absorb the full cost of what little emissions your outfit produces.

Is it just me, or do others see that something is truly going haywire in the system of incentives that the current crises-busting policies have adopted (by “crises”, I mean both the GFC and the CPC or Carbon Pollution Crisis)?

Of Thoroughbreds and Clunkers

Is it possible to design policies that simultaneously reduce carbon emissions and stimulate the economy?

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This past week saw the Australian Federal opposition led by Malcolm Turnbull and independent senator Nick Xenophon unveil a controversial alternate emissions trading scheme in a bid to outflank the Labor government in terms of its "green" credentials while at the same time shoring up its support from emitters in paticular the Minerals Council of Australia by limiting the effects the scheme would have on energy generators.

VIDEO: Opposition carbon plan

The minister for climate change Penny Wong quickly dismissed the proposal as a “mongrel” of a scheme while another minister and former union leader Greg Combet suggested that it sounded too good to be true. The Business Council of Austalia through Heather Ridout assailed it for passing the cost on to consumers and industry. The scheme it was said suffered from MPS or Magic Pudding Syndrome. The question is, are such schemes truly unworkable? Is it truly unrealistic to envisage something that reduces emissions and at the same time stimulates the economy?

Meanwhile in the US, the “cash for clunkers” program which saw many motorists trading in their old gas guzzling vehicles for cash as part of the American stimulus package got an additional appropriation of $2 billion from the US Congress as the original allotment of one billion was quickly exhausted in less than a week.

As made evident by its popularity such schemes are often unsustainable because they quickly run out of funds. The unfortunate thing was that the US government had to resort to deficit spending in order to finance it. But what if its financing came instead from another source? Such a question has been answered by Todd BenDor who modelled a workable system of Feebates, or rebates offered to retire old and undesirable vehicles (or to purchase fuel efficient ones) which are in turn funded by fees charged on fuel inefficient models.

BenDor's modelling shows that such a program would be sustainable and lead to immediate and long term reductions in vehicle emmissions. Much like the “sin taxes” imposed on tobacco and alcohol products and used to fund public health programs, this type of redistribution for the benefit of the environment is yet to be explored. There are other possible policies that can be designed with similar features. Can you think any? Post your ideas and comments here (scroll down to the bottom of the screen).

image credit: http://www.flickr.com/photos/threadedthoughts/3808715790/