On Jul 19, 1:11 am, Zeke Hausfather <[EMAIL PROTECTED]> wrote:
> I'm not entirely sure what you mean by a "conventional cap and trade"
> with a fixed price. Do you mean that the government would sell an
> unlimited number of short-term permits at an escape valve price? In
> that case, you would really be talking about a hybrid system, rather
> than a conventional cap and trade. Also, grandfathering under any cap
> and trade system is far from efficient, though it may be necessary for
> political reasons.
>
> To avoid reinventing the wheel on this, I'll quote something I wrote
> on the subject a few months back. My apologies in advance for any
> economic jargon:
>
> Two competing approaches have emerged in the effort to internalize the
> cost of climate change in the price of carbon emissions. The first is
> a price-based approach, where emitters of carbon pay a fixed price for
> every ton of carbon they emit. Under such a system, firms will choose
> to reduce emissions whenever emission abatement is available at a cost
> lower than the level of the carbon price. The second approach fixes
> the total quantities of emissions, and is a tad more complicated. In a
> quantity-based approach, the quantity of permissible carbon emissions
> is capped and firms are required to possess permits for each unit of
> emissions. In most modern variants, these permits are tradable between
> firms, and may or may not be bankable for use in future years. At the
> start of the quantity-based system, permits are either auctioned off
> by the government, distributed to firms based on the emissions of a
> chosen baseline year, or distributed annually based on emissions in an
> updating prior period. Firms with relatively high abatement costs will
> choose to buy permits on the market if the price of permits is lower
> than the cost of abatement. Likewise, firms with low abatement costs
> will reduce emissions and sell extra permits until the point at which
> the cost of further abatement equals the market price of permits. In
> an ideal world of perfect information and no transaction costs, the
> equilibrium outcome of taxes and tradable permit systems would be
> effectively identical, as both would result in firms abating to the
> point at which price of emissions (either the price of a permit or the
> marginal tax) is equal to the cost of abatement. In a world
> characterized by uncertainties, however, taxes and tradable permits
> can result in quite different outcomes.
>
> In his classic 1974 article, Prices vs. Quantities, Martin Weitzman
> pointed out that price-based and quantity-based approaches behave
> quite differently when the costs of abatement are uncertain. The
> relative effectiveness of each depends on the slope of the marginal
> abatement cost and marginal benefits curve. If marginal abatement
> costs are expected to be steep, e.g. each unit of emissions costs more
> than the prior unit to abate, a price approach will tend to limit
> potential deadweight loss that would occur under a quantity-based
> mechanism by capping costs should marginal abatement costs prove
> higher than expected, and allow for the optimal level of abatement
> should abatement costs prove lower than expected. If the marginal
> benefits curve is steep, however, a quantity-based mechanism can limit
> the deadweight loss that would occur due to inefficiently high or low
> abatement under a price-based mechanism. Thus steep marginal costs and
> flat benefits of abatement would tend to favor a price-based
> mechanisms, while flat marginal costs and steep benefits would favor a
> quantity-based mechanism.
>
> In the context of climate change issue, it is likely that price-based
> mechanisms will outperform quantity-based mechanisms, at least in the
> short term (Pizer 2002). Carbon dioxide is a classic example of a
> stock pollutant, where the marginal damages of a unit of emissions is
> solely a function of the existing concentration of CO2 in the
> atmosphere and a single unit of emissions has a negligible effect on
> the total stock. Hence the marginal benefits of abatement should be
> relatively flat over the short term. Likewise, marginal abatement
> costs are expected to be steep, as each additional unit of abatement
> will be more expensive than the prior one, and there is little time
> for innovation in abatement methods. If a pure quantity-based
> mechanism is implemented and marginal abatement costs prove higher
> than anticipated, firms could be forced to pay permit prices well in
> excess of the social cost of carbon, leading to a loss of welfare. In
> the long term, however, the situation changes considerably. Here,
> marginal benefits of abatement are expected to be quite steep, as the
> stock changes dramatically over time. Likewise, marginal costs of
> abatement are expected to become more flat as both endogenous and
> exogenous technological development drive down abatement costs. This
> has led some to suggest that the ideal mechanism for greenhouse gas
> abatement is one that acts like a price mechanism at the margin with
> the flexibility to behave like a quantity-based mechanism in the long-
> term by changing the price in response to changes in the slopes of the
> marginal cost and benefit curves (Stern 2006).
>
> Unfortunately, efficiency is not the only criterion that governs the
> policy-making process. In reality, efficiency is but one of many
> factors used in deciding which policies to adopt. Also important are
> concerns about effectiveness, in terms of how much emissions are
> actually reduced, concerns about equity, in terms of who has to bear
> the burden of emissions reductions, and concerns about what is
> political acceptable to the powerful actors. Quantity-based mechanisms
> (tradable permits) and price-based mechanisms (taxes) perform
> differently in their ability to satisfy these oft-competing criteria.
>
> Tradable permits
>
> Tradable permit systems have proven the most popular mechanism to date
> in both international climate negotiations and domestic policy
> proposals. They have the benefit of being more politically acceptable
> to firms, as virtually all tradable permit systems for greenhouse gas
> emissions implemented so far have grandfathered most permits to
> existing firms based on emissions from a particular baseline year.
> This reduces the compliance costs of firms vis-à-vis a tax and creates
> a barrier to entry for new firms in GHG-intensive sectors, giving a
> competitive advantage to those firms granted initial permit
> allocations. Trading in permits helps minimize abatement costs by
> allowing firms with high abatement costs to buy emission permits from
> those with low abatement costs. This is particularly important on the
> international level, where abatement costs differ widely between
> countries.
>
> Tradable permit systems allow the explicit separation of effectiveness
> and equity. Effectiveness is solely governed by the level of the cap,
> as climate change occurs based only on the total quantity of
> emissions, irregardless of who actually emitted them. Equity, on the
> other hand, is solely determined by the initial allocation of permits.
> This separation of efficiency and equity can be a mixed blessing,
> however, as equity issues tend to be highly controversial and
> efficiency can suffer if no equitable distribution can be agreed upon
> under a given cap. These issues are particularly important in the
> context of developing an international tradable permit system.
>
> Tradable permit systems also tend to lack a continuing incentive for
> abatement. Under a permit system, firms will reduce overall emissions
> to the point at which the total emissions of all firms is equal to the
> cap, but there is little systemic incentive incentive to make further
> reductions even if abatement costs prove lower than anticipated. The
> only way to achieve additional reductions is to reduce the total
> amount of permits in the system. This can be accomplished in two ways:
> either the government can reduce the emission allowance of all permits
> by a constant amount, or they can buy up permits from the market to
> remove them from circulation. The prior option could potentially wreck
> havoc on the market in the absence of a fixed schedule of reductions
> decided at the time of policy formation. As the recent experience of
> the European Trading System demonstrates, if people are uncertain what
> the value of permits will be in the future, changes in permit
> allocations can lead to dramatic spikes or drops in the market price
> of permits (Sterner and Muller 2006). However, creating certainty in
> the permit market limits the ability of the government to tighten
> permit allocations in the future in response to new scientific
> developments that clarify the social cost of carbon. The second
> option, buying up permits, may result in an unacceptable transfer of
> wealth from the government to firms, especially if initial permit
> distributions were grandfathered rather than auctioned. Additionally,
> the announcement of a large government buy up of permits could lead to
> a spike in permit prices and potential windfall profits to firms and
> traders.
>
> Finally, international trade in permits poses potential compliance
> issues. Countries initially allocated excess permits will have an
> incentive to sell their permits at the onset and later withdraw from
> the treaty when emission restrictions start to impose an economic
> burden. In the absence of trade sanctions on countries that withdraw
> from the treaty, which would prove problematic under international
> trade law, non-compliance may pose a huge problem. One way around this
> may be what David Victor calls "buyer liability" (2001: 69-74). In a
> buyer liability system, a permit becomes void if the initial issuer
> defaults on their treaty obligations. Thus all permits in the market
> would be explicitly priced based on the perceived risk of default of
> the issuing nation, and nations would have a strong incentive to take
> steps to reassure potential buyers against the risk of default. A more
> subtle but no less problematic form of non-compliance has been seen in
> the empirical experience of the European Trading System (ETS).
> Countries have had an incentive to allocate emission permits in ...
>
> read more >>
Might be a good time to post one of my half-baked ideas.
China has laid down a fairness principle that we should be taking into
account every molecule of CO2 pollution since the beginning of
Industrial Revolution.
Perhaps this issue could be addresses by making the US and Western
Europe pay or compensate for all that CO2 they have already put in the
atmosphere as part of a carbon trading system. Perhaps these
payments could help fund expensive transitions that will need to occur
in China and India.
One advantage to this is that it would be a way to put a price on the
fuzzy notion that the US and Europe needs to take the lead. And it
would give Europe credit for their current efforts while the others
like the US are dragging their feet.
BTW, there is another fairness principle from China: the notion that
per capita emissions should be important. I don't think the carbon
cap and trade system would address this.
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