Stavins: In Defense of Markets

An Economic View of the Environment

Robert Stavins is Director of the Harvard Environmental Economics Program.  This was original posted on his blog.

Cap-and-trade has been demonized by conservatives as part of an effective strategy to stop climate legislation from moving forward in the U.S. Congress.  As I wrote in my previous blog post (“Beware of Scorched-Earth Strategies in Climate Debates”), this unfortunate tarnishing of market-based instruments for environmental protection will come back to haunt conservatives and liberals alike when it becomes politically difficult to use the power of the marketplace to reduce business costs in the pursuit of a wide variety of environmental objectives.

Cap-and-trade has been vilified as a national energy tax, an elaborate Ponzi scheme, and a giveaway to corporate polluters.  The fact that none of these attacks are factually correct has not seemed to reduce their political effectiveness.  This is one element of the poisonous atmosphere which has come to dominate so much of national political discourse, at least in this election year.

When Senate leaders decided they could not assemble the sixty votes necessary to cut-off debate on meaningful climate legislation, they pulled nationwide, economy-wide cap-and-trade off the table, quite possibly until after a new Congress is seated in January of 2013.  But when serious attention is again given to meaningful national climate policy, as it surely will be, consideration will inevitably include carbon-pricing, whether in the form of carbon taxes or cap-and-trade, because these approaches have tremendous advantages over the alternatives (“The Real Options for U.S. Climate Policy,” June 23rd, 2010).

Therefore, it is important to set the record straight, and respond to at least some of the attacks that have been made on cap-and-trade specifically and carbon-pricing broadly.  That is the fundamental purpose of an Issue Brief Dr. Janet Peace and I have written.  Our report, “In Brief:  Meaningful and Cost Effective Climate Policy:  The Case for Cap and Trade,” was published by the Pew Center on Global Climate Change in June, 2010.  In today’s blog post, I will highlight just a few of our findings.

Questions and Concerns

While the justification for putting a price on carbon emissions seems straightforward to most policy analysts, some of the public and even some policy makers have questioned whether creating a market for greenhouse gas (GHG) reductions would be a cure worse than the disease itself:

  • Why employ market-based approaches to GHG emission reductions, when markets are subject to manipulation?
  • Would a market-based approach to reducing greenhouse gas emissions be a corporate handout?
  • Can markets be trusted to reduce emissions?
  • Will a market-based approach, such as cap-and-trade, be too costly?
  • Are other approaches likely to be more effective and less complicated?

In our Pew Center report, Janet Peace and I respond to all of these questions, but in today’s blog post I will highlight our response just to the first question.  For the full and complete story, I urge readers to see the original report, which can be downloaded freely from the Pew Center’s web site.

Why create a market for GHG emissions, when markets – in general – are subject to manipulation and have failed terribly?

With the U.S. economy experiencing its worst recession since the Great Depression, amidst corporate scandals, pyramid schemes, and a series of government bailouts, some members of the public as well as elected officials have come to question the ability of markets to perform their basic functions.  Despite the past successes of market mechanisms to address environmental problems such as acid rain, leaded gasoline, and stratospheric ozone depletion, this growing distrust of markets has led some to question whether market-based approaches are appropriate instruments to help tackle the exceptionally challenging problem of global climate change.

The storyline goes roughly like this:  establishing a “carbon market” for greenhouse gas emissions opens the door for financial intermediaries – banks and brokers – to be involved.  Since we know that they cannot be trusted, and only care about making profits (and not about reducing emissions), how could any approach that involves them be part of an effective solution?

In reality, of course, our recent economic turmoil does not mean that “markets” in any general sense do not work; only that markets require appropriate oversight.  Our economy fundamentally is a market-based system, but oversight – including, where appropriate, effective rules and regulations – can be essential to ensure transparency and prevent manipulation.

With appropriate rules and oversight, markets have been shown to work exceptionally well to address environmental problems.  They provide key flexibility to regulated entities to adopt least-cost approaches to emission reductions, while providing powerful incentives for technological innovation and diffusion, which serve to reduce costs over time.  Real world experiences with using market-based instruments for environmental protection include CFC trading under the Montreal Protocol (to protect the ozone layer); SO2 allowance trading under the U.S. Clean Air Act Amendments of 1990 (to curb acid rain); NOx trading (to control regional smog in the eastern U.S.); and eliminating lead from gasoline in the 1980s.

Studies that have evaluated the performance of these market-based approaches to environmental protection have found that they have achieved their environmental objectives and have done so at lower cost than conventional, command-and-control approaches.  Estimates of cost savings range from 7 percent to 96 percent, with more than half of studies showing that market-based programs cut the cost of regulation by well over 50% compared with command-and-control options.  For example, the SO2 allowance trading program resulted in 33 percent cost savings “” on the order of $1 billion annually, while reducing power-sector emissions from 15.7 million tons in 1990 to 7.6 million tons million tons in 2008.  The phase-down of leaded gasoline in the 1980s, which employed trading of environmental credits, was also successful in meeting its environmental targets, while yielding cost savings of about $250 million per year.

The evidence is incontrovertible – market-based approach to environmental protection can work, effectively achieving environmental targets and keeping costs to a minimum.  These approaches are not deregulation, but reformed and improved regulation.  And like all markets, these environmental markets need rules and oversight.

A Real and Pressing Problem

The fundamental reason why we face the threat of global climate change is that there is no price or cost for emitting greenhouse gases.  In the absence of a price, the damages associated with a changing climate are not considered by companies or individuals when they make their energy choices.  A cap-and-trade policy creates this price by establishing a limit on the amount of greenhouse gas emissions and allowing firms covered by the program the flexibility to trade allowances.  The environmental integrity of the program is ensured by the “cap” on emissions, and the costs of the program are kept as low as possible through the creation of a market (where firms can buy and sell allowances).

Concern about financial markets and fraudulent investment scams has created an atmosphere of distrust regarding the functioning and effectiveness of markets.  By extension, questions have been raised about the wisdom of creating a market with a cap-and-trade program for controlling greenhouse gases.  In truth, appropriate oversight and regulation of carbon markets will be required.  The problem has been the abuse of markets, not something fundamental about markets themselves.

Climate change is a real and pressing problem.  Strong government actions are required, as well as enlightened political leadership at the national and international levels. Creation of a market for greenhouse gas emissions can work, but is contingent on government action to establish this policy.  When the Congress decides to return to this issue ­- as it inevitably will – cap-and-trade policy specifically and carbon-pricing generally must be considered seriously and debated honestly, otherwise it will be fundamentally impossible to provide the right incentives to put the United States on a climate-friendly path of robust and sustainable economic growth.


P.S.  For those of you interested in the important climate policy developments that are occurring in the state of California, you may find of interest a conference organized by the University of California, taking place in Sacramento on October 4th, “California’s Climate Change Policy:  The Economic and Environmental Impacts of AB 32.”  You can learn more about it by clicking on this link.

— Robert Stavins is the Albert Pratt Professor of Business and Government and Chairman of Harvard’s Environment and Natural Resources Faculty Group.

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8 Responses to Stavins: In Defense of Markets

  1. richard pauli says:

    There is a true and severe real cost for emitting greenhouse gases — it is just that it is born by consumers, not by corporations. The market of consumers is getting destroyed. Hence economic depression.

    Markets seem to be chronological entities of the present moment. Almost the very definition of a market — but begs the question of future markets:

    What is the market in 5 years? What will the market be in ten or 20 years? And what is the market going to look like in the year 2100?

    Right now our markets seem to offer public information only on quarterly returns. Multi year planning seems to be very secretive. If I were a stockholder of any company, I would expect my corporation to have a climate change policy. And that current activity reflect that distant goal. That may be expecting too much.

  2. It is very odd that the Republicans claim to be against big government but that they want to respond to global warming by doling out money to energy technologies chosen by Congress – with a strong emphasis on nuclear and on carbon capture and storage, wasteful federal spending on technologies so expensive that they could never compete in the market. Changing our energy infrastructure is such a massive task that we obviously need a market-based strategy (such as cap and trade) that lets us use the least-cost methods.

  3. Ken Johnson says:

    Why does he keep beating this dead horse?

    “Real world experiences with using market-based instruments for environmental protection include …”
    RGGI, which just closed its latest auction at $1.86/ton. One quarter of the allowances went unsold.

    “… the SO2 allowance trading program resulted in 33 percent cost savings — on the order of $1 billion annually …”
    which is an order of magnitude smaller than the societal benefits that would have resulted if that $1 billion had been spent on scrubbers.

    “Are other approaches likely to be more effective and less complicated?”
    See “… Portugal shows U.S. how to move forward” and “Feed-in tariffs saved French ratepayers money …“.
    You won’t find any mention of such approaches in Stavins’ report. Just tired, worn-out dogma.

    If we’re serious about fundamentally changing our energy infrastructure we need to look beyond “least-cost methods” to “least-emission methods”.

  4. Andy Olsen says:

    1. “With appropriate rules and oversight” Not likely! In a country where we had bipartisan support to repeal Glass-Steagal Act the system should be designed with the expectation of less than appropriate rules and oversight.

    2. Carbon C&T is way different than for the earlier compliance trading schemes: the previous schemes do not validate C&T for carbon pollution. The number of measures that can compete for carbon pollution reduction are far more diverse, numerous and less reliable. Are the credits reflecting real, verifiable and permanent carbon reduction? Can we trust Congress to get that right?

    3. Wall Street has demonstrated they cannot be trusted, except to abuse the system. The public is wise not to trust them. Why put them in control of our carbon policy? They also have tremendous power in DC and are involved in writing the fine print of legislation, especially as C&T gets more and more complex, allowing more room for mischief. The gulf between the theoretical C&T construction and the “sausage” that comes out of our modern legislative process is immense and should be reflected in academic prognostications. We need simplicity to avoid gamesmanship, and leakage due to legislative horse-trading.

    4. The thing I do not like about it is that it mints a new right to pollute, based upon the trading of compliance paperwork. This is almost entirely ignored.

    Perhaps, like capitalism, it’s the worst possible system, with the exception of all the others. Let’s be realistic, though, and not blindly loyal to the policy.

    These views are my own.

  5. There are over 690 companies that are reporting their sustainability parameters by following the Global Reporting Initiative guidelines to varying and voluntary degrees (click to download spreadsheet going back to 1999 here):
    The Global Reporting Initiative is an organization that collaborates with the UN as a collaborating centre:
    GRI grew out of CERES, an environmental investors’ organizationbased in Boston:

    Many others have their own Corporate Sustainability or Corporate Social Responsibility Report. Some countries require this kind of reporting to comply with a national standard.

  6. Michael Tucker says:

    I WANT the US to address climate change and enact a system that will put a limit on greenhouse gas emissions. Just want to say that up front.

    We did waste all 8 years of the past administration and now we are going to waste 4 more from the current administration that, until the 2010 midterms, enjoyed a majority in both houses. Astonishing and utterly unbelievable!!!

    January 2013 you say. With a congress packed with zombies. I wonder which party will win the presidential election of 2012? How will it be possible to convince the broader electorate, some of whom support tea-bag sponsored Republican zombies, that urgent action is needed after the Democrats tolerated so much neglect and inaction?

    The Dems will say: no, no we were wrong in 2008. Urgent action wasn’t really needed at that time. BUT NOW (2013 OR BEYOND) it is important. We all know the real reason is President Obama just didn’t think that a climate bill would help with the 2010 midterms and he bet the farm on health care. So how does this help with the ‘urgent action is necessary’ message? How is health care helping get Democrats elected? I think this should be given as the definition of FUBAR.

    And, yes of course cap ‘n trade is the only viable method to reduce emissions.

  7. Ken Johnson @ #3: What happens when a new, better scrubber technology comes along? What if you make the larger scrubber investment and then the focus shifts, as from SO2 alone to carbon? Scrubbers are useless for countering carbon and NO2 pollution and poor at controlling mercury.

    As Joe has blogged several times recently, the expected global cost of adaptation to the results of unmitigated carbon pollution is expected to be $1240 Trillion and is as likely to be more than that cost as less. It may be several times more than that cost. We should agree that the focus must include mitigation strategies before adaptation is required. Then the question is: how do we effectively reduce carbon pollution with the least cost in terms of lives and money? The task is large, let’s get started. Yes, we can. Two implementations on the table are a carbon tax and cap and trade. In France, the electricity FIT may have been good, but why favor solar PV over all other renewable sources of electricity? Command-style regulation is littered with its own mines and is inflexible once in place.

    Andy Olsen @ #4: “The thing I do not like about it is that it mints a new right to pollute…”

    No one who advocates cap and trade would favor a static cap. The schemes always include a ratcheting down cap, as in CFCs, SO2, NOx, lead, etc. CFCs and HCFCs have been effectively eliminated from the market using a ratcheting cap.

  8. Jeff Hopkins says:

    Nice post, Dr. Stavins, here’s hoping we get it right next time, and that next time comes soon! Markets are powerful (although incentives are always underestimated ex ante), effective (Ken @ #3 – the answer to your question is $1.86 per ton across a portfolio of technologies that actually abate GHGs, not a billion dollars on mythical CO2 scrubbers) but all-too-easily vilified (Andy @ #4 – there will be a gulf between any idealized system and the sausage that comes out, e.g. cap and trade sausage, cap and dividend sausage, carbon tax sausage, RES sausage, command and control sausage, etc., if you don’t like cap and trade GHG sausage it’s probably because you haven’t tried the rest of them, next up…NSPS sausage!).