Back to the Drawing Board : Economics, Appropriation and Environmentalism

Cap and Trade vs. the Carbon Tax

Donny with an A — Fri, 13 Jun 2008 22:09:00 GMT

So I've been addressing the issue of anthropogenic climate change for some time now, and I haven't said much in the way of addressing specific policy proposals. But I was just given a delightful present by one of my fellow FEE associates: a copy of the American Institute for Economic Research's latest Economic Education Bulletin, entitled "The Global Warming Debate: Science, Economics, and Policy." I didn't read the whole thing, but my favorite part was definitely when William R. Cotton, a professor of atmospheric science at Colorado State, closed his completely science-oriented essay, "Summary View of Climate Change," with:

There are strong indications that our global climate is warming. But the question is, is the warming due to anthropogenic greenhouse gases, or is it due to some other forcing mechanisms (or their transient absence) and natural variability. As human population on Earth continues to increase, the chances of human-induced changes in climate due to greenhouse gases, aerosol pollution, or alterations in land use become increasingly likely. Thus, rather than consider climate engineering, we should devise methods of encouraging the reduction of population growth through economic and quality-of-life incentives.

Period, end of conversation. No comment on that gem anywhere else in the entire essay. Who's got two thumbs and loves it? This guy.

But anyway, that's not the point. Later in the publication was an essay by Kenneth P. Green, a resident scholar at the American Enterprise Institute, where it was argued that a carbon tax is superior to a cap-and-trade system. I bounced between frustration, amusement, and glee as I read it, and felt an immediate need to comment. Not because Green did a bad job--he did just fine--but because he was guilty of something which is very common among people who discuss climate change: he discussed the possible "solutions" to climate change without addressing the reasons that a policy was to be implemented in the first place, and how the different solutions worked to address those reasons. His argument for a tax scheme over a cap-and-trade scheme was simply that a tax scheme could achieve the same goals, but with better economic side-effects and less potential for failure. Fine, I'll even grant it. But taxes and caps are fundamentally different policies, which only make even a little sense when confronted by specific sorts of problems.

I should explain what I mean. I've discussed elsewhere the idea that in order to make any sense from an ethical point of view, pollution taxes need to be based on the idea that an individual is justified in polluting if and only if she pays compensation to her victims for any damage done to them. That idea is controversial, but for our purposes we don't need to address that controversy. The point is only that even if we accept that idea as true, there are still only certain kinds of instances in which the injustice of pollution can legitimately be dealt with through a tax on pollution. The paradigm cases are those instances in which the damage caused by pollution is directly proportional to the amount of pollution that there is, so that the tax becomes the "price" of compensating the victims of one's actions for the costs one imposes upon them.

Cap and trade schemes, on the other hand, are built for an entirely different kind of problem. In a paradigm cap and trade situation, there is a threshold level of pollution with which policymakers are concerned, and at the threshold, a certain amount of damage is anticipated. The cap and trade scheme accordingly sets the cap at the relevant amount of pollution, and then distributes "shares" of the "environmental space" below that threshold in some way (e.g., auction, grandfathering system...). Because the allocations may be economically inefficient for whatever reason, the shares can then be traded in accordance with the wishes of their owners in order to ensure that the right to pollute is distributed to those individuals who are willing to pay the most for it (note that the normal objections to the "willingness to pay" criterion are avoided by passing the buck to the distribution process, which of course must be justified separately).

The point I want to make here is that global climate change is a very different phenomenon than the sorts of phenomena for which either of these policies is built to provide a solution. As noted elsewhere, climate change is an emergent problem. That is, climate change is not the result of any individual's actions, but rather is the consequence of many individuals acting separately, so that no individual can reasonably be said to have been able to prevent climate change from occurring, and no individual could have caused climate change singlehandedly. Accordingly, it does not make sense to talk about the consequences of climate change in terms of marginal contributions. The amount of damage caused by climate change will not likely change recognizeably with an additional increment of CO2 (or any other forcing agent), so it's not reasonable to try to put a price on how much damage "a unit of climate forcing" (expressed, perhaps, in terms of GWP, or Global Warming Potential, as defined by the IPCC?) causes.

A tax on contributions to climate change, therefore, seems like a policy which would require a bit of shoehorning. Individuals paying the tax would not be paying the "social cost" of their particular contribution, taken in isolation, because that would be basically zero. They would need to be charged for their "portion" of the total amount of damage done by climate change. So what policymakers would need to do would be to determine the total amount of damage which would be done at the equilibrium price for pollution permits, and then sell the permits at that price. The problem then becomes one of economic calculation. It could be done to some degree, but it would be inherently imprecise. And remember: the end result needs to be that the victims get compensated, so the government would have to go into its own pockets (that is to say, the pockets of its treasury or, more realistically, the pockets of its Federal Reserve printing press) to take care of the balance if it aimed low. And as my wonderful economist friends would point out, there would be a considerable incentive to aim high, creating a surplus revenue stream for the government which would almost certainly not be returned. So the tax is doable, kind of, but the problem is not the kind of thing that the tax is designed for. It's just that you can use the tax to accomplish the end goal if you want.

The cap and trade system is a little harder to adapt to the task, but there are a number of ways that the idea can be useful. First, there is a level to which we could collectively exert a forcing on the climate system without producing objectionable consequences. This level of climate forcing is a threshold which could be amenable to a soft cap and trade scheme (soft like the baseball salary cap). In this kind of policy, the cap would be set at the level of forcing which would produce no negative consequences, and this "environmental space" would be allocated somehow (or, if people find this to be a bad idea, we would simply say that these shares should be allocated in proportion to one's contribution to climate change, so that the soft cap has no effect). People not receiving these shares, or polluting in excess of their shares, would be filling environmental space which represented something like "harmful social emissions". Because these emissions would not be legitimated by the soft cap, they would be the ones which would be subject to the obligation to compensate the victims (again, if the soft cap isn't being used, as mentioned above, it would just be that everyone would have to participate in compensating the victims).

Here a potential for another cap would become apparent: We might imagine that policymakers would decide on a level of pollution (corresponding to some amount of total damage) which was determined to be "socially desirable" somehow. Perhaps, using the same reasoning involved in the tax scheme discussed above, the policymakers would arrive at the level of pollution which would clear the market if everyone paid some price for it. Or perhaps the policymakers would identify a level of pollution beyond which unacceptable results would occur, and the cap would be set there. In any case, you would then have to set a cap and allocate the shares. So again, the policy could be made to work. But the problems are simply that it's difficult to identify a level of "unacceptable" pollution, it's just as difficult to identify a market clearing price in this scheme as it is with the tax (assuming that the shares are auctioned, of course), and any other way of running the scheme is sure to carry either difficulties of its own, or charges of arbitrariness which would sever the connection between the problem and the solution.

So ultimately, what we're faced with is a situation in which the only two policy suggestions that are on the table are not particularly well suited to the task of "solving" the problems arising from climate change (and I haven't even begun to address the question of how the compensation process would even work, or whether compensation could make climate change legitimate!), and the only way to make either of them work is to basically stretch and contort them until they are made to do the job acceptably. Doing so, it will be noted, requires in both cases that government decision-makers possess knowledge and foresight which they almost certainly do not have, and even then it's unclear that the policies would work properly.

Obviously, there's a lot more to say about this. I just wanted to get some preliminary thoughts down, and I think this was a good start.

Can the Free Market Solve the Problems Posed by Climate Change?

Donny with an A — Thu, 20 Mar 2008 22:22:00 GMT

[Cross-posted on the parent blog]

When confronted by the possibility of climate change, many libertarians default to the position that the free market, with its ability to mobilize the ingenuity of the economy for the satisfaction of the desires of the people, will provide the solutions we desire. I want to discuss this view, because I think it is the result of a mistaken understanding of the nature of the free market. For an example of this view, consider George Reisman's comments in his essay, "Environmentalism in the Light of Menger and Mises":

The appropriate answer to the environmentalists is that we will not sacrifice a hair of industrial civilization, and that if global warming and ozone depletion really are among its consequences, we will accept them and deal with them--by such reasonable means as employing more and better air conditioners and sun block, not by giving up our air conditioners, refrigerators, and automobiles.

In his essay, "Global Warming Is Not a Threat But the Environmentalist Response to It Is," Reisman elaborates:

...if global warming is a fact, the free citizens of an industrial civilization will have no great difficulty in coping with - that is, of course, if their ability to use energy and to produce is not crippled by the environmental movement and by government controls otherwise inspired.

He goes on to say that global warming

...would certainly not be too great a problem for tens and hundreds of millions of free, thinking individuals living under capitalism to solve. It would be solved by means of each individual being free to decide how best to cope with the particular aspects of global warming that affected him.

Reisman makes an important point. When it comes to allocating resources efficiently, the free market is unparalleled in its effectiveness. In his essay, "The Use of Knowledge in Society," Hayek explained:

...knowledge of the circumstances...never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all...separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate "given" resources--if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge not given to anyone in its totality.

Hayek points out that

...there is...a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others in that he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation.

He concludes:

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its orders. We must solve it by some form of decentralization.

This decentralization is the free market. Hayek explains that

...in a system where the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan.

And indeed, it's been demonstrated in practically every instance that the free market has the capacity to satisfy the wants of the population better than centrally organized alternatives. So I think Reisman is largely right in saying that when it comes to adapting to new problems, the market does do great work.

But when we talk about the free market, we generally have two things in mind. The first, which Reisman focuses on, is a system in which property titles are traded voluntarily in a mutually beneficial way, resulting in a continuous progression towards a more efficient allocation of resources. But the second, which underpins the first, is a system in which rights are enforced, so that individuals who infringe on the rights of others are punished, and those whose rights are infringed are compensated for the harm they suffer. It is my contention the Reisman's argument breaks down by completely brushing off this second feature of the market.

Imagine if we were trying to discuss the proper social response to a particular theft. It might be true that of all social systems, a victim of theft would be best equipped for dealing with her loss in a capitalistic free market. She would not need to consult a central planning board in order to replace the things that were taken, and her higher purchasing power, enabled by her participation in a thriving market economy, would enable her to afford the replacement with comparative ease.

And yet we would obviously not be satisfied with this "solution." The reason is simple. The thief did something wrong, and therefore, the thief ought to be held responsible for fixing it, never mind that we should perhaps have tried to stop the theft from happening in the first place. Accordingly, by suggesting that we simply allow the free market to operate so that adaptation will be easier, Reisman is smuggling in the claim that we do nothing wrong to the victims of climate change.

This seems obviously contentious. The question should not be, as Reisman seems to want to make it, whether or not the free market is the best system for facilitating adaptation to changing conditions. The question is whether we do something unjust by contributing to climate change. To be fair, Reisman briefly addresses this issue, as I discussed here. But my point is that by glossing quickly over the issue of justice, many libertarians have completely missed the point. If the free market is to be relied on to provide a "solution" to climate change, it must be through a strict adherence to the principles of justice. If we simply ignore injustice, and define fairness in terms of mere participation in the market, then we cannot claim to be advocating libertarianism.