Transcript ppt

Market-based strategies: Cap & trade
brainpickings.org
Market-based strategies: Cap & trade
Known by many names:
marketable/tradable/transferable + permit/right/allowance/quota
Generically:
“marketable permit”, “tradable permit system”
• Pollution: “tradable emissions
allowances”, “transferable
discharge permit”
• Development: “transferable
development right”
• Fishing: “individual transferable
quota”
brainpickings.org
Instrument taxonomy
The goal of C&T is to cost-effectively control the aggregate level
of activity (pollution, resource use) by letting agents sort out who
most values permit use.
•
Key regulator design
decisions
– scope: who’s regulated
– cap: quantity of permits
– initial allocation of permits
•
Regulator allocates permits &
sets up a market for permits
to be exchanged between
agents
– agents decide:
(1) how many permits to use 
how many they need to buy/sell,
(2) [sometimes] how many to bank
for later use (or borrow).
Example: SO2 tradable emissions
allowance market
The problem:
• 1980s: scientists discovered that lakes, streams, and forests - even
buildings and statues - were being damaged by acid rain.
– Effects: robs soil of nutrients, can make lakes uninhabitable for aquatic
life, damages man made objects.
– Congress authorized a ten-year, $570-million study to determine the
cause, and a major culprit was found: sulfur dioxide (SO2),
• air pollutant generated by power plants and other industrial facilities.
From US EPA website: http://www.epa.gov/acidrain/images/origins.gif
Effect of acid rain on a forest, Jizera Mountains, Czech Republic,
http://en.wikipedia.org/wiki/Acid_rain
Sources: http://www.etei.org/case_study_1.htm, http://www.rff.org/documents/RFF-DP-00-38.pdf
SO2 Allowance Market
The policy response
• 1990: Congress revises the Clean Air Act
– A yearly cap on SO2 emissions was established (also NOx)
• Scope: Began with the largest emitters (1995) then expanded to
cover all fossil-fuel electric power producers (2000)
• Ratcheting: Yearly cap decreased with an ultimate target of 50%
of 1980 levels by 2010 (17.5 million tons of SO2 were emitted in
1980).
– Also instituted an emission allowance trading program
• The industry is allocated a fixed number of total allowances
• Firms are required to hold one allowance for each ton of sulfur
dioxide they emit.
• Firms are allowed to transfer allowances among facilities or to
other firms or to bank them for use in future years
– The Environmental Defense Fund helped to write the revision
Sources: http://www.etei.org/case_study_1.htm, http://www.rff.org/documents/RFF-DP-00-38.pdf
SO2 Allowance Market
SO2 Allowances Transferred
Under the Acid Rain Program
Allowance Prices (1994-2010)
http://www.epa.gov/airmarkets/progress/
Schmalensee &
Stavins 2012
Cost effectiveness comparison over
alternative instruments
If we had perfect foresight
over what was going to
happen to prices for permits
and important inputs like lowsulfur coal. (Source K&O, p. 187)
SO2 Allowance Market
• B = 10*C: Overall the benefits of the program are around 10 times greater
than the costs
– The prediction was: B = C (Portney 1990)
• Compliance cost: one-half or less of what was anticipated in 1990 (Burtraw,
2000)
– Some savings from trading
– Primary source of savings: flexibility in choosing abatement strategy in the firm
(Hahn, 2000)
• Fuel switching (e.g. low-sulfur coal made cheaper through railroad
deregulation),
• Innovation -- Not typically patentable discoveries, but rather subtle process
changes and changes in markets and organizational behavior
• Most of the estimated benefits have come through reduced risk of
premature mortality by reducing exposure to sulfates (Burtraw, 2000)
SO2 market surprises
• put in place to curb acid rain, but main source of
benefits from it was unexpected
• main source of cost-effectiveness was an
unanticipated consequence of earlier railroad
deregulation
• cap-and-trade now demonized by conservative
politicians (yet, initially championed and
implemented by Republicans)
• court decisions and regulatory responses have
led to the collapse of the SO2 market (what the
government gives, the government can take
away)
(Schmalensee & Stavins 2012)
How TDP works – “simple” example
• 2 emitters (A, B)
• What is the level of total
unregulated emissions?
• Suppose:
– policy goal: 50% overall cut
– allocation rule: proportional to
pre-existing emissions.
– A: 0.5*120 = 60 permits
– B: 0.5*90 = 45 permits
• Under the initial allocation, is the
equimarginal principle satisfied?
• Who would have an incentive to buy
permits? Sell permits? (Think
marginally!)
• Note: A is the lower cost abater, B
is the higher cost abater
Are there gains to be had from trade?
• The last unit abated by B cost ~ $4K
• B would be WTP <= ~$4K to
avoid abating that last unit
• The next unit abated by A would cost
~$1.2K
• A would be WTA >= ~$1.2K to
abate another unitfreeing up a
permit for B to use
How TDP works – “simple” example
From the initial
allocation, A (LCA)
reduces emissions by
one unit to free up a
permit to sell to B
(HCA). E.M.P.
satisfied? If no,
repeat….
How TDP works – “simple” example
• 2 emitters (A, B)
• What is the level of total
unregulated emissions?
• Suppose:
– policy goal: 50% overall cut
– allocation rule: proportional to
pre-existing emissions.
– A: 0.5*120 = 60 permits
– B: 0.5*90 = 45 permits
• At the predicted equilibrium of the permit market between these two:
• Is the equimarginal principle satisfied? Why should we care?
• After trading, has the total quantity of emissions changed?
Carbon offsets
• Carbon offsets: a tradable credit for reducing
carbon emissions by some amount (e.g. ton)
generated outside a regulated system,
recognized within a regulated system (e.g. a
cap-and-trade regime) as a substitute for holding
and using an emissions permit. "Regulatory"
offset.
– "Retail offset": An offset marketed to individual
consumers. Possibly but not necessarily recognized
by any institutional authority.
Retail offset:
Attributes for carbon offset
effectiveness
Offset issues: is the offset…
• Real: has the unit of emissions actually been avoided and not just
claimed?
• Additional: was the unit avoided due to the offset policy or would it
have been avoided regardless of the offset mechanism? (Was this
criteria satisfied in the “Cheat Neutral” ‘example’?)
• Permanent: is the unit avoided permanently or only temporarily (e.g.
will a planted tree just be burned in 10 years)?
• Verifiable: can we ensure that each attribute above is actually
attained so that stakeholders in the over-arching climate policy can
ensure that the policy is not being undermined?
Criteria for policy evaluation:
Efficiency
vs.
Moral precepts
"A tax on child pornography, for example, might be
more efficient than certain criminal penalties in
limiting the prevalence and severity of such
activity; however, taxation would be considered a
morally unacceptable policy in this instance
because laws are important instruments for
forming and communicating ethical values” (Sterner,
2003, p. 198).
Morality & markets
Michael J. Sandel
Harvard Professor
of
Political Philosophy
“markets are not mere
mechanisms”… “they also
embody certain norms” (p. 64)
Some markets are unequivocally unacceptable.
Sandel’s
ex’s:
• kidneys
• baseball
players
• bearing
children
Deirdre
McCloskey
• Professor at University of
Illinois at Chicago
• Distinguished Professor of
Economics, History, English,
and Communication
• she transitioned from male to
female in 1995, at the age of
53, writing about her
experience in a New York
Times Notable Book of the
Year
McCloskey, D. N. (2012) The Poverty of Communitarianism, Book Review of What Money
Can’t Buy: The Moral Limits of Markets, by Michael J. Sandel. Claremont Review of Books
XII(4), pp. 57-59.
Sandel’s moral
objections to
markets
Corruption
Unfairness
erodes norms, damages
attitudes, reduces stigma
worsening inequality is
bad
McCloskey:
Sandel’s “much better
argument is that it
can cause the Sacred
to be spoiled by the
Profane.”
McCloskey: “Sandel does not face the actual, moral problem—which is…real
poverty. ….fiddling instead of solving…is morally indefensible.”
“The…policy for the $1-a-day wretched of the earth is to allow capitalism to rip,
which is what China has been doing since 1978 and India since 1991, with
vastly more gain to the poor than from communitarian policies.”
gapminder.com
McCloskey’s key critique is that Sandel offers no
framework for thinking through lower vs higher
norms or what the appropriate norm is
• According to McCloskey, Sandel’s only analysis is:
– "we corrupt a good, an activity, or a social practice whenever we
treat it according to a lower norm than is appropriate to it" (p. 46)
– Sensible….
• But Sandel provides no philosophical framework for
deciding what is lower, and why we are disgusted when
professional ethics in banking, say, is corrupted by sheer
maximization of profits.
– why are disgusted by certain examples (e.g. child trafficking)
and how should we think carefully about such questions when
we're in a more gray area (e.g. carbon offsets)?
McCloskey: “Sandel worries, properly, that the
market can crowd out the sacred. …And what
about crowding in?”
• Crowding out: reduction of moral stigma of polluting,
undermining of spirit of shared sacrifice to reduce
emissions.
• Crowding in:
cheatneutral.com
“Cheat Neutral”
• 0:18 - 2:40
– Q: "Have you ever cheated on your girlfriend?" A: "…No, certainly not.
Cause that would be wrong."
– “…The total levels of heartbreak have not gone up.“
• 3:25 - 5:12
– "...cheating and jealousy are just a natural part of most modern
relationships, and what we needed was a market-based solution to
dealing with that."
– Q: "Does that make sense?" A: “…No."
– "What we're making sure is that the total amount of cheating doesn't go
up. So if you want to cheat it's no longer something you have to feel
bad about…"
– Offset price: $5.
– "All we're doing is taking this well-established concept of carbon
offsetting and moving it into the arena of cheating and relationships."
Additional slides to review on
your own
Transferable discharge permit
system (TDP)
• The most frequently employed market-based environmental
instruments in the United States (Stavins, 1998)
State and regional programs
(Hahn, 2000)
Setting the level – the cap
• Similar thought process to setting a performance
standard or Pigovian tax (if efficiency is the
goal).
• The total cap is often ratcheted/reduced over
time by the regulator (e.g. S02)
– Reasons:
• technological improvements lower the efficient level
• softens initial impact on industry (gradual adjustment to
stringent ultimate target believed less costly).
Initial allocation of permits
• As long as the initial allocation is fairly well dispersed (to avoid a
permit trading monopoly), the resulting trading market should not be
greatly affected. (Cost-effectiveness likely not affected.)
• The particular rule or formula will have distributional impacts
• Example allocations
– Give them away
• Equal number of permits per firm
– BUT firms differ in size
• According to firms’ share of pre-existing emissions
– BUT rewards bad actors
• According to firms’ share of goods market
– Sell them
• Auction
– Involves a transfer to government
– Hybrid (give away fraction then sell remainder)
Political economy of
cap and trade
• C&T has emerged in the U.S. as most
likely the lead instrument to control GHG
emissions. WHY?
• Political economic story over next slides
summarized by J.Broder (2009. “From a Theory
to a Consensus on Emissions” (5/16/09)
New York Times).
http://www.nytimes.com/2009/05/17/us/politics/17cap.html?_r=4&scp=1&sq=cap%20and%20trade&st=cse
Political economy of C&T
• Previous take on C&T from many of those
support C&T today:
– “an industry-inspired Republican scheme to
avoid the real costs of cutting air pollution.”
• The preferred approach they said
(previously) was:
– “strict government regulation, state-of-the-art
technology and a federal tax on every ton of
harmful emissions”
Political economy of C&T
• Congressional history:
– 1993: President Clinton “proposed a tax on all
forms of energy, a plan that went down to
defeat and helped take the Democratic
majority in Congress down with it a year
later.”
• Horse trading:
– C&T is highly amenable to the “buying and
selling of political support” through the permit
allocation process (to industries and particular
congressional districts).
Political economy of C&T
• Previous success: the SO2 model
– During the Bush (Sr.) administration a C&T plan for
SO2 reductions was outlined in the White House and
sent to Congress.
– This C&T plan became a critical component of the
amendments to the Clean Air Act in 1990,
“considered by many to be the most successful
domestic environmental legislation ever enacted.”
– Even after vigorous debate in congress the target
held: “roughly 50 percent reduction in emissions over
the next decade”
Is a C&T system essentially
equivalent to a tax?
• W. David Montgomery (1971 doctoral
thesis on emissions trading)
– “It [a C&T approach to GHG control] is a steel
fist of regulation covered by a velvet glove of
emission trading….”
– “Why not just impose a carbon tax?”
“Companies Earn Big Profits From Free Carbon Credits”*
•
“During his election campaign, President Barack Obama pledged to
institute a system in the United States where all permits would be
auctioned. That could avoid the mind bogglingly large windfall profits
made by utilities in Europe.”
•
“The head of the nation’s largest burner of coal for power generation
last week signaled his group’s determination to fight for a significant chunk
of free allowances under any United States system, according to Reuters.”
– Michael Morris (chief executive of American Electric Power):
“If you auction all of the credits, then it’s just a carbon
tax,”… “So let’s forget the game. Let’s call it a carbon tax,
and let’s see if the populace wants to have a carbon tax.”
•
*Source: New York Times (03/09/09):
http://greeninc.blogs.nytimes.com/2009/03/09/companies-earn-big-profits-from-freecarbon-credits/
Setting up the market for permit trade
• General rule: simple and clear rules (keeps “transactions
costs” low)
• Single overall market for permits where buyers and sellers
can interact openly and where information on prices is
publicly available to all participants.
• Added transactions costs will likely hurt the efficiency of the
market
– If trades require regulator approval, the additional bureaucracy and
uncertainty will generate transactions costs.
• Who is allowed to trade?
– Just polluters? Third parties (e.g. private citizens, NRDC) who’d
like to buy/retire permits?
Setting up the market for permit trade
• Normal forces of
competition would bring
about a single price
• Permits would tend to flow
LAC  HAC polluters
• LAC: Low abatement
cost polluters would be
those with better preexisting technologies
AND/OR those who
have invested in better
abatement technologies.
• Our equilibrium prediction
is that MACA = MACB = p*
What is the
predicted MAC
of each firm
after trade?
Supply: LAC
polluters or
firms leaving
the business
Demand:
HAC
polluters,
expanding
firms, or new
firms
TDP and Incentives for R&D
Under performance standard at e1
• What is the incentive to innovate (to MAC2)?
Model for an individual firm:
Under a TDP system, with market permit price p
• Suppose initial allocation of permits is A=0
(firm must buy all permits it needs on the open
permit market)
•
What is level of abatement? Permits required?
(Under MAC1? MAC2 ?)
•
What is the total cost of compliance (TCC) for
the firm including total abatement cost (TAC)
and total permit cost (TPC)? TCC = TAC +
TPC
•
What is the incentive to innovate?
•
How does the incentive to innovate under TDP
compare to that under emissions charges (at
least in theory)?
---------------------------------------------------------------• Alternatively, suppose that A = e1. Does the
abatement level change? Does the TCC go up
or down? Does the incentive to innovate
change?
Note: when many firms are involved, we
will assume that each firm treats the
permit price as fixed, i.e. their own buying
and selling of permits is too minor to
affect the market permit price. This is
different then the simple 2 firm example
previously discussed.