Memo to America: Don’t do Cap’n’Trade!

Senator Harry Reid denounces Republican opposition to President Obama’s Cap’n’Trade proposals as “dangerous”.  Senator Reid is wrong.  It is the Climate Bill itself which is dangerous.  Fortunately the Bill’s recent set-back could well be terminal.

Emissions trading is wrong at so many levels.  First of all, there is a growing realisation that the small changes we are seeing in the Earth’s climate are entirely consistent with well-established, long-term natural climate cycles, and that CO2 – a minor trace gas in the atmosphere – has a trivial effect on climate.

Secondly, many studies have shown that the action we propose to take, even if implemented, would have a trivial impact on the trajectory of climate – perhaps a tenth of a degree by 2100.

Thirdly, most of the authoritative economic studies on Cap’nTrade show that the costs greatly exceed any conceivable benefits.  So far as I know, the UK’s Stern Review is the only major study which seems to show that “the cost of inaction exceeds the cost of mitigation”, and Stern has been comprehensively and authoritatively refuted.

A number of commentators, including notably former UK Finance Minister Lord (Nigel) Lawson, have argued that if any action is called for, then adaptation, as and when the need emerges, is a conservative and precautionary approach, which is hugely cheaper than mitigation, and avoids massive up-front costs to deal with a highly speculative problem.

Those who are still tempted by Cap’n’Trade should look at the EU’s Emissions Trading System (ETS).  In summary, it has failed to achieve reductions in emissions (the recent recession has done a much better job).  It has created massive perverse incentives and unintended consequences.  And it has imposed great costs on the EU’s economies.

There are some excellent studies, including those by London think-tank Open Europe (www.openeurope.org.uk), which document the ETS.

If we want to reduce emissions (and as I have argued, the case for doing so is increasingly doubtful), then Cap’n’Trade is simply a bad way to do it.  It depends enormously on initial conditions which are set by bureaucrats, which in turn creates a huge lobbying industry as businesses seek to influence the conditions for their competitive advantage.

Who measures the emissions?  What is the cut-off point for the minimum size to qualify?  What grandfather rights do we offer for existing emitters?

Imagine two similar companies side-by side.  But one is just above the threshold, one just below.  The smaller one has a massive competitive advantage.  Or two similar companies, one of which has completed a major energy efficiency programme.  Under grandfathering, the efficient company is penalised, while the less efficient is rewarded.  Grandfathering also sets up barriers to entry, and penalises entrepreneurship and innovation.

In the EU, this was exacerbated by different initial allocations in different member-states.  So the UK, seeking to follow the spirit of the rules, set low initial allocations, while France and Germany were more realistic, and more generous.  As a result, British companies short of permits were for several years paying around £500 million a year to continental companies, which had plenty.

Carbon prices were both volatile and, frequently, too low to create the desired incentives.

As a conservative, I hate new taxes, but a carbon tax (ideally off-set against other taxes to be revenue-neutral) would be more efficient, more inclusive, and more predictable than Cap’n’Trade, and would avoid the perverse incentives and barriers to innovation.

The UN’s Clean Development Mechanism (CDM) effectively extends Cap’n’Trade internationally.  The reason that Russia signed up to Kyoto was not that their climate-skeptical political and scientific establishments wanted to cut emissions.  But knowing that inevitable restructuring of Russian industry would in itself cut emissions radically, they saw the opportunity to make billions by selling carbon credits to the gullible West.

Recent studies show that the EU, through CDM, is subsidising Chinese and Indian companies that compete directly with EU companies, while at the same time creating incentives for EU industries to move elsewhere, and for international investors to avoid Europe.

We must be mad.  America: please don’t follow our example.

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