Climate

Obama, cap-and-trade, and voodoo economists

Last week I blogged on the President’s remarks to the Business Roundtable about why he campaigned on 100% auctioning of CO2 permits: “If you’re giving away carbon permits for free … it doesn’t work.”

A couple of leading mainstream economists who opine on the weather (MEOWs) hissed and pawed at the President because he supposedly made a couple of errors in his remarks, E&E News (subs. reqd) reported Friday night.

The first thing to say is that as The Economist (!) magazine itself labeled economists, “a tribe renowned in the wider world for its desiccated view of human welfare” (see “Voodoo Economists 4: The idiocy of crowds or, rather, the idiocy of (crowded) debates“).

The second thing to know about the question of whether CO2 allowances created by a cap-and-trade bill should be auctioned or allocated (i.e. grandfathered to polluters or given away for free) is that most economists support auctioning off the vast majority of apartments — see, for instance, “Statement by economists supporting 100% auction of carbon permits.

The third thing to know about the argument for pursuing a CO2 cap-and-trade system is that the case was largely built around the success of such a system for reducing SOx emissions. In particular, the system succeeded in achieving reductions at far lower costs than the the models of the energy sector or conservatives had predicted (see “Wrong Again 1: Business Attacks Climate Security Act“). This was (and is) the centerpiece argument for a cap-and-trade, as I can test from my tenure running the DOE Office of Energy Efficiency and Renewable Energy in the months leading up to the Kyoto protocol.

That was Obama’s point when he said of the system he proposes:

… industries [will be] thriving as opposed to groaning under the weight of it… I’m confident that we can do it. We’ve done it before.

I mean, keep in mind that when — I’m trying to remember, this was back in the ’70s or early ’80s — I’m getting old enough now where I can’t remember — but, you know, the issue of acid rain was around. Everybody thought all your trees were going to be dying; you couldn’t make any paper. And we put in an auction system and a trading mechanism and, lo and behold, American ingenuity and American entrepreneurship and inventiveness created options that ended up being much cheaper than anybody had imagined — much cheaper than anybody had imagined.

I praised the President for correctly making the core argument — total costs will be far lower than businesses are warning against.

Now, as E&E News notes, “the 1990 law signed by President George H.W. Bush required U.S. EPA to auction about 3 percent of the cap-and-trade credits. Electric utilities got the rest for free based on their historical emission levels.”

So Harvard University’s Robert Stavins said,

“I’m not sure that’s the example one wants to give,” Stavins said, citing instead the Northeastern states’ Regional Greenhouse Gas Initiative, which so far has required electric utilities to purchase credits via auction.

Meow!

But why would Obama want to cite RGGI, which is far too recent to be cited in defense of anything?

Unlike Stavins, I am quite sure that sulfur trading was the example Obama wanted to give because it is the best documented example to prove the specific point he was making. And the White House made an important point:

The White House aide did not dispute the small role of an auction in EPA’s acid rain program. But the staffer noted, “As the first major pollutant cap-and-trade program, EPA worked to hold periodic allowance auctions to facilitate price discovery.”

What about the supposed other “error” Obama made?

Now, the experience of a cap and trade system thus far is that if you’re giving away carbon permits for free, then basically you’re not really pricing the thing and it doesn’t work, or people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for.

The MEOWs hiss at this:

A pair of leading climate economists say the president’s comments glossed over a key point in the cap-and-trade debate.

So long as the government caps emissions, companies will see a price signal and be forced to act, Harvard University’s Robert Stavins said.

“If you give permits away for free or sell them, either way, allowances will be priced and the system will work,” Stavins said in an interview. “There may be sound arguments that the administration wishes to make for auctioning allowances, but the functioning of the price mechanism and the environmental performance of the system is not one of them.”

Dallas Burtraw, a senior fellow at the nonpartisan Resources for the Future think tank, agreed with Stavins’ assessment.

“The way that the allowances are distributed matters hugely for the success of the program,” Burtraw said. “But for the most part, it does not matter directly for the kinds of emission reductions you’re going to see. The primary influence is the existence of an emissions cap.”

Well, the MEOWs are on a little firmer ground here, but everybody glosses over a lot of points when they talk about this subject, including the MEOWs. First, as the White House noted:

The staffer explained that the president was referring to the pilot phase of the European Union’s trading system between 2005 and 2007, when credits were given away to electric utilities for free.

“And, in fact, too many were given away,” the aide said. “This excess allocation caused the price of allowances to collapse in 2006 and trade at such a low level in 2007 they were, in essence, not creating a price signal.”

This was the president’s primary point, and, again, I’m glad he understands this.

Now it is probably true that it is the total number of permits, rather than what the government does with them, that affects price “for the most part” — at least in the very short term. But had the EU auctioned off a higher fraction of their permits — and had a smarter auctioning process — then they would have found out much sooner that the total number or permits was too high.

So whoever in Congress is designing the cap-and-trade should indeed take to heart what the president said and make sure the system allows for quick price discovery.

And let’s get back to Butraw’s “for the most part” caveat on his criticism. The fact is that if you give away this incredibly valuable commodity — a permit to emit CO2 — to existing polluters, you can be certain that you are enriching them, but you can’t be certain that all they will do anything useful with the money to keep costs low. They might, as in the acid rain case. Or they might keep dawdling on technology investment — while spending vast sums of money on lobbying and advertising — as they have been doing for the past 10 years on climate (see “Like Detroit, the coal industry chooses (assisted) suicide“).

Obama, however, wants to spend $15 billion a year aggressively developing and deploying the clean tech needed to keep costs low. And yes, I trust Obama and Energy Secretary Chu more with the money than the coal industry.

Let me end with an excerpt from a Norwegian analysis of “Auction-based permit trading“:

The point of market-based instruments in environmental policy is precisely that we want to put a price on pollution. Then the market itself will ensure that the greatest possible emissions reduction takes place at the lowest possible cost — whether it be a question of cleaner technologies or a restructuring of business and industry. However, if obstacles block the path of the market mechanism by introducing conditional allocation of permits, then investment and operational decisions will be directly affected by the allocation itself. Then the system is no longer cost-effective, which was the whole point of introducing market-based instruments.

The restructuring of business and industry is an important element in an economically sensible system for emissions reductions. It requires both technological solutions and a switch from CO2-intensive goods and services to those that are more environmentally sound. Thus we must not remove incentives to reduce the production of carbon intensive goods — which is what occurs when firms that produce such goods have their allocated permits revoked when activity is reduced, and are even offered more permits when they increase their polluting production. Today’s emissions trading system helps maintain artificial life in firms that should not exist in a world where CO2 emissions have a price.

It is absolutely crucial that we don’t just hand out permits to, say, utilities with grandfathered coal plants, since that would merely provide a huge incentive to keep those plants running.

I was quoted in the E&E News story:

Joe Romm, a senior fellow at the liberal Center for American Progress, argued that while Obama’s response may have been incomplete, it was not inaccurate. “If this is what passes for something that economists worry about,” he said, “I have to think they’re taking their eye off the ball.”

Precisely.

And let’s remember that Stavins is the last guy on the planet who should be criticizing anybody for citing examples that supposedly don’t support their argument. Recall what he told the New Yorker‘s Elizabeth Kobert and Van Jones’ goal of combining your climate strategy with your economic strategy to create green jobs (see “Economists are part of the problem, Part 1: Robert Stavins can’t walk and chew gum at the same time“):

When I presented [Van] Jones’s arguments to Robert Stavins, a professor of business and government at Harvard who studies the economics of environmental regulation, he offered the following analogy: “Let’s say I want to have a dinner party. It’s important that I cook dinner, and I’d also like to take a shower before the guests arrive. You might think, Well, it would be really efficient for me to cook dinner in the shower. But it turns out that if I try that I’m not going to get very clean and it’s not going to be a very good dinner. And that is an illustration of the fact that it is not always best to try to address two challenges with what in the policy world we call a single-policy instrument.”

In short, whatever we do to address climate must not attempt to create jobs. And whatever we do to create jobs should make no effort whatsoever to get off our self-destructively unsustainable economic path. That would not be a Pareto optimum, I guess.

Again, Dr. Stavins, just because you haven’t figured out how to walk and chew gum at the same time, doesn’t mean nobody else can.

I think we can safely say that Stavin’s “cook dinner in the shower” example makes Obama’s examples worthy of a Nobel Prize in economics .

One final note: I am not saying here that a cap-and-trade system is the best of all possible strategies for stabilizing atmospheric concentrations of CO2 at levels needed to preserve a livable climate. It ain’t. For that, price is really secondary (or tertiary). What we need is a WWII style strategy. See, also this useful post by Gar Lipow at Grist, “Emissions trading: A mixed record, with plenty of failures.”

19 Responses to Obama, cap-and-trade, and voodoo economists

  1. Rahul B says:

    Joe,
    I haven’t been able to find details on Obama’s plan regarding how the system will be phased in. Will this target the few most energy intensive sectors at first as we saw in Phase I, or have a wider initial sectoral scope?

    I’m also wondering about the political feasibility of introducing a price floor into the US scheme, and if that would/could then be echoed in the EU and New South Wales. Or, in the next several years or possibly in Copenhagen, will we be seeing some sort of global linkage?

    Finally any rumors on the prevalence of project based credits? I’m familiar with the GAOs criticism of the CDM, but would be interested in hearing if CERs would be allowed into the system at all.

    I just returned from the UK premiere of the ‘Age of Stupid’….possible upcoming post? Cheers

  2. ids says:

    The SOx C&T also increased GHG emissions because the cheap switch to Wyoming coal fixed one danger (rivers and trees dying from acid) and caused another (catastrophic global climate change). Cheap- you get what you pay for.

    And please, the power suppliers will pass the auction cost to consumers, the government rebates taxpayers/consumers. If you pay more for something then charge more or get a rebate, the advertised price is misleading. So when considering the $/mmt, it is far less than what meets the eye under O’s plan. I don’t blame the Chinese for having doubts of America’s sincerity to put a lid on climate change.

    To the roundtable, O seemed to link the net auction revenue to the costs to mitigate climate change, not so much to using the revenue to reduce accelerating emissions. $15B for green infrastructure is probably less than the subsidies going to coal at the same time it’s being taxed. It is a sham.

  3. Harrier says:

    Of course, Obama’s EPA could just regulate coal-fired power plants out of existence using the Clean Air Act.

  4. ecostew says:

    In addition, NEPA! Yes we can!

  5. Len Ornstein says:

    Joe:

    over at Roger Piellke, jr’s blog::

    # RogerCaiazza Says:
    March 13th, 2009 at 9:12 am

    “I have been involved with market-based pollution control programs since the inception of the acid rain program so I want to comment on the history of acid rain vs. CO2.

    I disagree with the following: “Now, the experience of a cap and trade system thus far is that if you’re giving away carbon permits for free, then basically you’re not really pricing the thing and it doesn’t work, or people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for.” If the President is in fact making the distinction between CO2 cap and trade programs and those for other pollutants then we agree that they don’t work for CO2 but only disagree why.

    Respectfully Mr. President I think that cap and trade programs work because they price the “thing” efficiently. For pollutants that can be controlled with add-on equipment or fuel characteristic changes the cap and trade model works well. Remember what we are talking about: a cap is established to limit pollution, allowances are allocated to affected sources equal to the cap and those sources are required to meet the cap by turning in an allowance for each ton of pollutant emitted. It works because the cost of controls varies, primarily because the cost per ton removed is lower for a larger unit. As a result, the cost of allowances eventually equals the costs of control.

    On the other hand, cap and trade is not a good model for CO2 because there are no cost-effective control options for existing sources and fuel switching to a different fuel type is necessary to get reductions. Ultimately then meeting the cap has to be done indirectly and it becomes difficult if not impossible to price CO2 rationally.

    [JR: Argument just fell apart. You can skip the rest of it.]

    If that was the primary rationale for going to cap and auction in CO2 programs, then I would not be as disappointed by the rhetoric: “people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for”. However, the proponents for cap and auction are as interested in sticking it to the affected sources by making them pay up front as any other reason. Ultimately, the CO2 incentive structure envisioned is a tax by another name to pay for renewable energy, energy conservation and energy efficiency.

    If you really want the free market to reduce CO2 then replace other taxes with a CO2 tax. The free market will decide how best to incorporate the cost of carbon in society. Unfortunately, the cap and trade charade will create the ultimate system for gaming. The feeding frenzy of lobbyists over all the aspects of the CO2 cap and trade is ugly now and will only get worse.”

    It seems to me he says it all!

    Someone should have Obama, Chu and Holdren read thiis.

  6. Andrew says:

    I’m glad the power producers are doing all they can to save us from increased electricity costs. The pushed through deregulation of electricity production and transmission here in Texas and allowed us to have some of the highest rates in the country. How nice of them!!!! Oh, they just love us poor peons so, so much. Power plants flipped ownership like a lumberjack going through a plate of pancakes. Each time the major shareholders, i.e. the CEO and board of directors engineering the sale, made billions. Yes, billions. I wish that was an exaggeration, but it’s not. Who’s paying for this? The customers of course. I have to laugh when I hear about the “doomsday” scenarios given for future electric costs the power companies use to scare us; as we get to pay those rates today. 18c a kilowatt hour. What a bargain!!!! I surely hope Obama and congress maintain some level of sanity and get us through this first step.

  7. paulm says:

    must read article for those concerned with disseminate the Climate Change message…

    Scientists on the streets
    To get the climate change message across, environmental scientists need better arguments – and more public protests
    (Simon Lewis, Royal Society fellow and specialist on tropical forests)

    “Furthermore, as those who are not listened to have shown throughout history, targeted protests and civil disobedience can have a major impact. A day spent on the street, rather than in my case being in the lab, office or rainforest field site, might be my most useful service to humanity in this pivotal year. It’s probably the same for the majority of us.”

  8. paulm says:

    Related…lead by Hansen joined by Simon Lewis

    Day of climate change protests planned
    Environmental activists will hold a day of protest this week, in an attempt to persuade the Government to drop plans for new power stations and a third runway at Heathrow Airport.
    http://www.telegraph.co.uk/earth/environment/climatechange/4995872/Day-of-climate-change-protests-planned.html

    ….
    “One power plant with a lifetime of several decades will destroy the efforts of millions of citizens to reduce their emissions,”

    “If the government permits the building of new infrastructure which locks us into a future of high CO2 emissions, there is a moral obligation to try to stop them”.

  9. Mark Shapiro says:

    Joe, ever since the kerfuffle over Van Jones-green jobs-Elisabeth Kolbert-Robert Stavins I’ve been thinking about economics and economists, and reading some of them (and of course my head hurts).

    Robert Stavins is an ally, not a foe. He wrote a paper in 2007 calling for a U.S. cap and trade system: ksghome.harvard.edu/~rstavins/Papers/Stavins_HP_Discussion_Paper_2007-13.pdf
    And his blog seems very good, too (detailed, technical, clear, but not easy reading): belfercenter.ksg.harvard.edu/analysis/stavins/

    The previous post you linked to above: “Voodoo Economists 4: The idiocy of crowds or, rather, the idiocy of (crowded) debates“ was justifiably angry, but wasn’t about economists at all. It was about Crichton, Huber, Lomborg, and Stott — liars who maddeningly win debates with cheap tricks. The difference between them and Stavins (and the bloggers at env-econ.net and commontragedies) is night and day.

    Joe, this is a friendly fire incident. Cease fire.

  10. Fred Heutte says:

    No less than Nicholas Stern took down the MEOWs last week at the climate science conference in Copenhagen. And he named one crucial name: William Nordhaus, who had given an impassioned oration for globally aligned national carbon taxes (with the tax rate somehow magically made the same everywhere) the day before on the same stage. Nordhaus pointed to the centuries of experience with taxes and belittled the new and unproven nature of market-based regulation.

    Stern replied that Nordhaus was entirely wrong on the assessment of carbon tax vs. cap-and-trade and said further that mainstream economists had completely failed to take into account two key aspects of the climate crisis: the longevity of atmospheric CO2 and the scale of the overall greenhouse effect and the needed responses.

    Concerning carbon taxes, Stern pointed out that while they might be theoretically efficient, unlike a capped carbon market approach they don’t provide certainty of emission quantity reductions nor lead to cross-border financial flows to stimulate investment in mitigation and adaptation. He said there were things in favor of and against both carbon taxes and capped markets and implied that Nordhaus was pulling his punches by only giving the favorable points on taxation.

    This must have pleased Michael Grubb, who has long argued that carbon taxes sufficiently large to reduce emissions at the scale needed can’t be achieved politically, in addition to the economic limitations. Grubb was the chair of the previous day’s panel and following the Nordhaus speech made a comment that suggested he was ready to take this on but decorum did not allow it. But Stern made up for it and then some, while leaving out any argument about political viability.

    Stern said much, much more including provocative comments about the central importance of equity to a new global climate agreement, and he conceded that the 550 ppm scenario in the Stern Review is far insufficient compared to what the current science says.

    Overall a remarkable statement and some hope that conventional economics is not doomed (and to be sure, Stern is still a quite conventional economist).

    To view Stern’s speech, go to climatecongress.ku.dk, find the list of the plenaries on the right side, and click on the listing for March 12, 9-10:30. Like the conference itself, the web site is badly organized and I don’t know if a direct link will work.

  11. Maarten says:

    Markets function when property rights are defined, well, properly. Even conservative economists will agree with that, Richard Posner is just one example.
    No property rights, no markets, see, for example, the case of overfishing. Related to CO2 the question is, who owns the atmosphere. The atmosphere is owned by all of humanity, not by the few polluters, because the atmosphere was not created by the polluters. Thus, the right to pollute must be paid for. Thus CO2 emission permits need to be auctioned, not given away.

  12. Joerg Haas says:

    There is a good report from the European Research Group Climate Strategies on the Role of Auctioning in Emissions Trading:
    http://www.climatestrategies.org/reportfiles/role_of_auctions_09_oct_08final.pdf
    Here is are the main findings:
    Within a given cap allowances can be either given out for free or auctioned. Extensive analysis and accumulated evidence suggests the following:
    1. Within the framework of the EU ETS as a multi-period scheme with a series of direct and indirect updating provisions, free allowance allocation distorts the carbon price signal for efficient investment, operation and consumption choices; uncertain future allocation rules complicate investment decisions.
    Auctioning creates a robust policy framework, ensures efficient corporate and private decisions that contribute to the most economical response to climate policy, and removes uncertainties about further changes in the allocation scheme.
    2. The wide range of options for free allocation of allowances was used by many Member States, in the first two phases of the EU ETS, to offer support for the continued use of carbon intensive technologies and production processes. These approaches delay market opportunities and create uncertainties for low-carbon alternatives.
    Auctioning creates a clear and transparent market framework for innovation and investment in low-carbon processes, products and services.
    3. Free allowance allocation distributes public assets to the operators of installations, which are often financially strong companies. These companies are not required to use the income either for investment and innovation in low-carbon options or for any other activity that benefits the country that issues the allowances.
    Auctioning creates government revenue to support innovation, cooperation with developing countries, tax reductions to support economic growth and to address the economic hardship of high energy prices for poor households.
    4. Free allowance triggers public opposition to windfall profits, as illustrated by the 2006 debates in Germany, Netherlands, UK, Spain and Scandinavia. This can spread to other countries and sectors, and undermine support for EU ETS. National responses, such as windfall profit taxes, also create investment uncertainty and can create distortions between European countries.
    Auctioning provides a fair and simple scheme to enhance public support for climate policy and thus contributes to long-term investment security.

  13. I suppose that this blog is more in favor of cap and trade, but I don’t understand why smart people like you and Stern are thinking so.
    First the argument of quantification in favor of cap and trade just doesn’t work: today we cannot precisely assess the ghg emission level of the whole earth, how could we define the precise target decreasing year after year, with the underlyng asssumption that this target cannot be overpassed?
    Then there is the problem of the great quantity of emissions made by personnal choices (driving heating, eating, …); how on earth can you imagine that an oil distributor, like Exxon or Total will stop distribution because its quota is over? When will this happen with a yearly quota, in october, in december? This is kind of utopia or fancy world.
    There is also the argument against tax that the progressive increase of oil tax will not be strong enough to lead the customer to cut its oil expenses. So use a bigger progressive increase; also consider that this is a long term message, and that it will have a huge political reverberation that will drive every customer to reassess its way of consumming and living.
    On the other hand, with cap and trade (with auction of course) the repercussion of the cost of auctions will not be clear nor tractable, while the simplicity of the price signal is essential to get the majority of citizens on board with this huge societal move toward a low carbon economy to save our future.
    For me, the main argument in favor of cap and trade is that it doesn’t contain the word tax. But the situation is grave enough to adress this semantic and political issue in front.
    For french readers: http://taca.asso-web.com/

  14. One concern, which I think is reasonable, is: what will happen to the revenue from the auctions? Is it just another tax for the general fund?

    Will it be like payroll taxes? Even if, like Social Security, it is supposed to be in a lockbox for a special purpose (research and development), more pressing emergencies always seem to arise, and that is where the money ends up. How can we keep Congress from looting carbon auction money for bridges to nowhere?

  15. David B. Benson says:

    I want an Excess Carbon Removal Fee assessed on all fossil fuels.

  16. bicultural says:

    Joe, what do you think about the cap and dividend idea? http://www.capanddividend.org. James Hansen appears to be on board. Seems to make a lot of sense in terms of winning political (populist) support.

  17. Bicultural:
    Where have you read that Hansen supports capanddividend. On the contrary, his latest statement is that he would prefer no agreement in Copenhague rather than a cap and trade agreement.
    The capanddividend video is interesting because it clearly shows that this is a fancy solution or a sheer wild world. It features a woman cyclieng and a hummer driving. So it means that the cap organizes the oil scarcity, rising the price of oil, and the ones that can afford the price buy oil, the others cycle. But this is not an acceptable way to move toward a low carbon society. the scarcity management cannot be just based on money, they are essential human needs that must be guaranted, specially in a crisis time.
    Instead a progressive rise of a carbon tax, progressively rising the price of carbon products and services (up to 4$ per gallon within a 10 years ramp up ie), with dividend on an equal basis, gives the simple and right price signal to favor our individual purchase or our business investment towards low carbon solutions.

  18. bicultural says:

    Jean, he is quoted on the capanddividend website as supporting 100% dividends, but it looks like technically you’re right, he wants tax and dividend, not cap and dividend. As the editor states, though, these can be functionally equivalent. A progressive drop in the carbon cap should work similarly to a progressive rise in the carbon tax, no?

    see http://www.capanddividend.org./?q=node/135