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.
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.”
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.”