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Brooks Wilson's Economics Blog: Stavins On Cap-and-Trade

Monday, June 29, 2009

Stavins On Cap-and-Trade

Greg Mankiw linked without comment to an excellent article by Robert Stavins titled "The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey," and published May 27, 2009. He defends cap-and-trade as a method to reduce pollution in general and its specific application to reducing carbon emissions through the Waxman-Markey bill. I do not know if he would support the bill in its final form. Stavins makes several points about the efficiency of cap-and-trade that he (and I) believe are not well understood. Perhaps the most important point to remember is that a cap-and-trade system efficiently reduces emissions regardless of the allocation of initial permits.
Generally speaking, the choice between auctioning and freely allocating allowances does not influence firms’ production and emission reduction decisions. Firms face the same emissions cost regardless of the allocation method. When using an allowance, whether it was received for free or purchased, a firm loses the opportunity to sell that allowance, and thereby recognizes this “opportunity cost” in deciding whether to use the allowance. Consequently, the allocation choice will not influence a cap’s overall costs.
Stavins believes that
...the political process of states, districts, sectors, firms, and interest groups fighting for their share of the pie (free allowance allocations) serves as the mechanism whereby a political constituency in support of the system is developed, but without detrimental effects to the system’s environmental or economic performance. That’s the good news, and it should never be forgotten.
I believe that he is largely correct in stressing that the political allocation does not affect cap-and-trade's environmental impact, but I disagree that it is a health process. Stavins implicitly assumes that the bill is necessary and that building a constituency for it is a political necessity. Politicians can bribe carbon emitting special interest groups with allowances if they support the bill or extort support from them with the threat of higher taxes if they don't. Bjorn Lomborg refers to the alliance of politicians and pocket lining businessmen as the "climate industrial complex."

I will illustrate the point with an example. Representative G. W. Green has two carbon emitting producers in his district, Coal Inc. and Dairy Farms. Each will suffer net losses of $100 if the bill passes. Green informs them that the first to announce their support of his vote for the bill will receive allowances valued at $120 paid for by taxes on the other emitter. Dairy Farms caves first, and earns a net profit of $20. Coal Inc. stands on principles and pays the cost of $220. Its not difficult to envision bills passing that are bad for the country but are vociferously supported by special interests who have been paid off. Let me emphasize that Stavins carefully explains how the allowances were allocated as of the publication date and that consumers were the primary beneficiary. My normative value is that $1 of allowances allocated to a consumer is of no more value to society than $1 of allowances allocated to any other group. I suspect that I am of the minority position yet again.

Finally, Stavins lists his concerns of which I mention two. He seems to prefer an auction to free distribution of allowances.
First, auction revenue may be used in ways that reduce the costs of the existing tax system or fund other socially beneficial policies. Free allocations to the private sector forego such opportunities. Below I will estimate the actual share of allowance value that accrues to the private sector.
I agree that auction revenue might be wisely used, but that there is a high probability that it will not.

Stavins and I share a concern about the impact of cap-and-trade on the competitiveness of the United States in international markets. He is optimistic about potential solutions; I am not. He writes,
The only real solution to the competitiveness issue is to bring non-participating countries within an international climate regime in meaningful ways. (On this, please see the work of the Harvard Project on International Climate Agreements.)
As a skeptic of anthropogenic global warming theories and particularly catastrophic predictions of death and destruction, I recommend that those interested in global warming and possible solutions read Stavin's original article and the links in his quotes. Given the assumption that global warming is largely a man-made problem, he gives good analysis of possible solutions.

1 comment:

  1. Jason Haddock1/7/09 11:55 AM

    For starters I'll point to the EPA report that was covered up showing that global warming doesn't exist. That aside, cap and trade is a terrible policy. Companies will line the pockets of beaurocrats to get allowances. Additionally extra costs incurred by manufacturers will pass directly to the consumer. This increase in goods, coupled with our current economic situation, is a recipe for economic collapse. While the fed continues to print money and pump it into the system (causing inflation), and the president borrows money to pay for the last stimulus, and prices rise for goods, we move toward an economy not unlike that of Germany after WW1, where it took a bucket of cash to buy simple goods like a loaf of bread.

    Cap and trade is also an opening to our foreign competitors. China and India will look at the US raising costs of manufacturing, and will in turn raise the cost of our doing business there and raise the cost of their exports to us. This also is terrible for the American consumer.

    Finally cap and trade is unconstitutional. It is a reach for our liberty, and a move toward a soft tyranny. Simply its is a power grab by the statists.