I introduced my previous post by noting that there are several prevalent myths regarding how economists think about the environment, and I addressed the “myth of the universal market” —the notion that economists believe that the market solves all problems. In response, I noted that economists recognize that in the environmental domain, perfectly functioning markets are the exception, not the rule. Governments can try to correct such market failures, for example by restricting pollutant emissions. It is to these government interventions that I turn this time.
A second common myth is that economists always recommend simple market solutions for market problems. Indeed, in a variety of contexts, economists tend to search for instruments of public policy that can fix one market by introducing another. If pollution imposes large external costs, the government can establish a market for rights to emit a limited amount of that pollutant under a so-called cap-and-trade system. Such a market for tradable allowances can be expected to work well if there are many buyers and sellers, all are well informed, and the other conditions I discussed in my last posting are met.
The government’s role is then to enforce the rights and responsibilities of permit ownership, so that each unit of emissions is matched by the ownership of one permit. Equivalently, producers can be required to pay a tax on their emissions. Either way, the result—in theory—will be cost-effective pollution abatement, that is, overall abatement achieved at minimum aggregate cost.
The cap-and-trade approach has much to recommend it, and can be just the right solution in some cases, but it is still a market.
Therefore the outcome will be efficient only if certain conditions are met. Sometimes these conditions are met, and sometimes they are not. Could the sale of permits be monopolized by a small number of buyers or sellers? Do problems arise from inadequate information or significant transactions costs? Will the government find it too costly to measure emissions? If the answer to any of these questions is yes, then the permit market may work less than optimally. The environmental goal may still be met, but at more than minimum cost. In other words, cost effectiveness will not be achieved.
To reduce acid rain in the United States, the Clean Air Act Amendments of 1990 require electricity generators to hold a permit for each ton of sulfur dioxide (SO2) they emit. A robust permit market exists, in which well-defined prices are broadly known to many potential buyers and sellers. Through continuous emissions monitoring, the government tracks emissions from each plant. Equally important, penalties are significantly greater than incremental abatement costs, and hence are sufficient to ensure compliance. Overall, this market works very well; acid rain is being cut by 50 percent, and at a savings of about $1 billion per year in abatement costs, compared with a conventional approach.
A permit market achieves this cost effectiveness through trades because any company with high abatement costs can buy permits from another with low abatement costs, thus reducing the total cost of reducing pollution. These trades also switch the source of the pollution from one company to another, which is not important when any emissions equally affect the whole trading area. This “uniform mixing” assumption is certainly valid for global problems such as greenhouse gases or the effect of chlorofluorocarbons on the stratospheric ozone layer. It may also work reasonably well for a regional problem such as acid rain, because acid deposition in downwind states of New England is about equally affected by sulfur dioxide emissions traded among upwind sources in Ohio, Indiana, and Illinois. But it does not work perfectly, since acid rain in New England may increase if a plant there sells permits to a plant in the mid-west, for example.
At the other extreme, some environmental problems might not be addressed appropriately by a simple, unconstrained cap-and-trade system. A hazardous air pollutant such as benzene that does not mix in the airshed can cause localized “hot spots.” Because a company can buy permits and increase local emissions, permit trading does not ensure that each location will meet a specific standard. Moreover, the damages caused by local concentrations may increase nonlinearly. If so, then even a permit system that reduces total emissions might allow trades that move those emissions to a high-impact location and thus increase total damages. An appropriately constrained permit trading system can address the hot-spot problem, for example by combining emissions trading with a parallel system of non-tradable ambient standards.
The bottom line is that no particular form of government intervention, no individual policy instrument—whether market-based or conventional—is appropriate for all environmental problems. There is no simple policy panacea. The simplest market instruments do not always provide the best solutions, and sometimes not even satisfactory ones. If a cost-effective policy instrument is used to achieve an inefficient environmental target—one that does not make the world better off, that is, one which fails a benefit-cost test—then we have succeeded only in “designing a fast train to the wrong station.” Nevertheless, market-based instruments are now part of the available environmental policy portfolio, and ultimately that is good news both for environmental protection and economic well-being.
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Comments
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Bart Anderson Posted 5:49 pm
27 Feb 2009
In the real world, government agencies are dominated by the corporations and other entities they are supposed to regulate.
One cannot discuss environmental regulation meaningfully without getting into the conflicts of interest that are intrinsic to the process.
This means getting into nitty-gritty history - listening to the different voices. Tales of success and tales of corruption.
For example, there are all sorts of stories emerging about how cap-and-trade is actually working out. I trust an empiric collection of experiences much more than theoretical discussions.
Imannuel Kant: "Experience without theory is blind, but theory without experience is mere intellectual play."
Bart
Energy Bulletin
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JMG Posted 6:35 pm
27 Feb 2009
sulfur was an undesired byproduct of burning coal that could be (a) either be substituted by using western (low Sulfur) coal or (b) treated by scrubbers;
sulfur clears from the atmosphere rather quickly, compared to carbon's 1000+ year lifetime.
Thus, programs that allow the highest-intensity carbon sources to continue emitting (by buying allowances or, worse, fictitious future reductions a/k/a offsets) are doing nothing but guaranteeing that even more radical cuts will have to be made in the future (and that future generations will curse us for having allowed the highest-carbon-intensity emitters to continue in order to satisfy the market fetish of the economic priesthood).
The 5% Project
Let's live on the planet as if we intend to stay.
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Ken Johnson Posted 12:40 am
28 Feb 2009
Case in point: The EU-ETS is currently achieving its caps at about $10/ton. Never mind that the caps are not significantly different from business-as-usual; the "environmental certainty" of the cap is being achieved at low cost. From a cost-effectiveness perspective, the low prices are a good thing and the program is a triumph of success. From the standpoint of economic efficiency, the EU-ETS is a joke, a dismal failure.
Another case in point: The U.S. SO2 trading program continues to focus regulatory incentives on further cost reduction, not further emission reduction, even though trading prices have been a fraction of original expectations, and even though SO2 emissions remain about a factor of five higher than the threshold of sustainability and additional SO2 reductions would yield a societal return-on-investment of well over 1000% -- mainly from human health benefits.
Yet another case in point: The California Air Resources Board's plan for AB 32 implementation projects that passenger vehicle emissions could be further reduced at a incremental net savings of $262/ton. But why bother? Under CARB's planned cap-and-trade system any such further reductions would not translate into statewide emission reductions -- they would be offset by higher emission allowances in other sectors, reducing the trading price below the currently-projected $10/ton. Never mind that receding coasts and expanding deserts may lay waste to California's economic infrastructure; CARB currently has no intention of going beyond the bare minimum statutory requirements of AB 32.
Fast train. Wrong station.
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GreenMom Posted 12:51 am
28 Feb 2009
Trading or no trading, the bottom line is that the program will succeed if we have the political will to set a low enough cap. And it won't succeed if we don't.
Whether or not there's trading is a second-order issue.
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waves16 Posted 1:03 am
28 Feb 2009
Mark C. Henderson replicated those forces in a strategy that is applicable to the entire environmental agenda (see http://www.wavesofthefuture.net/). If you can make green markets profitable as happened last summer, you will have the massive power of the business sector (including billions of dollars in R&D) working for the environment just as happened last summer, INSTEAD OF AGAINST IT. The result was undeniable.
Robert (and anyone interested in this topic): you ought to take a look at Henderson's environmental strategy.
Tags: environmental strategies & markets
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Pompey Road Posted 1:29 am
28 Feb 2009
I have been screaming about the corpocracy since I have been posting, lobby reform should have been the first thing tackled if Obama was to have any chance with either the economic recovery , alternative energy sustainable renewable, or addressing the carbon problem..
The regulation you alluded to or lack of really is what caused the economic melt down. Deregulation of the markets and allowing commercial banks and wall street to mingle was a catastrophic mistake. All the old Roosevelt regulations and acts to separate the two had to be nullified before we could self destruct, no matter they had worked for 60 years with moderate success.
If GM as about every other corporation had been paying more attention to the wants and needs of the American market instead of devoting most of their capital and energy in the China market they might not be on the verge of bankruptcy now. A healthy portion of our effort for recovery, alternative energy, and all environmental concerns should be guided by a manufacturing philosophy of build it here. A fool can looked at the hyper growth rate of China and the swelling of the ranks of their middle class and see how important manufacturing was to their success. We need the service, tech and info sector but the 30 year planned dumping of our manufacturing base boarders on the criminal when you look at the part the corporate lobbyist played in dismantling the sector of the economy that sustains the middle class and pays the bills.
We should have already had universal health care and a universal retirement fund that everybody pays into to relieve the corporations of the so called legacy cost. Social Security should be as it was originally set up. For old age pension and the truly disabled, no SSI or Medicare prescription plans the pharmaceutical companies wrote. Al Gore's lock box will be only for the I.O.U.'s now. The unfunded liabilities will hamper balanced budgets for decades to come. If left as it was originally set up even at the lousy 2 % interest Social Security would have been solvent for the next 150 years. If every body had not been dipping into it and throwing an I.O.U. back in the box.
A 180 degree shift from trickle down and deregulated markets will have to be undertaken and it will take a decade of reconstruction to repair the damage that has been done over the last 30 years.
The eons of time and nature was good to us down here. It was not until we become civilized that destroying our habitat become fathomable or fashionable.
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Pompey Road Posted 1:36 am
28 Feb 2009
Chrysler is toast now matter what you do for them and even the Japanese Car Companies are claiming a major downturn in car sales and posting losses.
The eons of time and nature was good to us down here. It was not until we become civilized that destroying our habitat become fathomable or fashionable.
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amazingdrx Posted 3:05 am
28 Feb 2009
We could try to understand the point of view of "economists" as a broad general class, but that way lies madness.
And it would not be helpful as far as curing the economy and the climate. A better way to get where we want to go, a green job and manufacturing cure for both climate and family finances, would be to go directly to solutions, ignoring the advice of this strange amalgam of free marketeers and economists who believe in reasonable regulation.
You are starting out with a fatally flawed analysis, sorry Robert.
Find an economist like Krugman that believes in carefully regulated markets and ask him the right qusetions. That might just illuminate the issues around climate and recession, as it illuminated the credit crisis in the PBS presentation, "Frontline: Melt Down".
Otherwise it's nothing but a diversion from reality into dogmatic theory laden nonsense.
http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin
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JMG Posted 3:37 am
28 Feb 2009
p.s. Anyone fantasizing that economics is a science needs to look at what college departments it resides in - the Social "Sciences," which are well separated from the real sciences. Colleges need to wake up and start a separate college of Mythology, and put it there, along with all other government theologies and bean-counting and other, more entertaining, religious/astronomy myths. Maybe there's even a branch of Psych called Psychology of Mythology?
The 5% Project
Let's live on the planet as if we intend to stay.
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amazingdrx Posted 4:22 am
28 Feb 2009
It's a theory, a computer model that predicts the future, based on examining the past. If a trader knows where the line on the graph of any traded commodity on an electronic screen will go even a few times a month, with over a 50% certainty, then that trader can eventually beat the roullete wheel.
These theories are touted daily from univerity classrooms to spam emails in the billions per day.
A fed chairman or teasury secretary that has the knack of understanding the prevalent (delusional) theory operating in the mind of traders might even be able to keep us safe from disasters like the one we are experiencing now.
But these traders never are able to rely on a predictive model, it is like predicting the next flip of a coin based on a million previous flips, the accuracy won't exceed 50%. You would be right only half the time and that produces no advantage for the casino capitalist sitting at the roulette wheel. Herding the collective consciousness of these hopeless gambling addicts is impossible.
So the government needs to put up fences to keep the herd metality from driving us over a cliff. Those fences are regulations.
The reason that economics is a voodoo seance, intead of a science, is that it mainly panders to degenerate gamblers. If you don't believe it take a look at chart reading trading courses online. It's like I-Ching or chicken bone reading.
The really high end outfits, like LTCM, used fancy computer modeling, instead of chicken bones, same result. but much bigger disasters, in the 100s of billions. Now this current credit crisis is on the order of 800 trillion.
When economics embraces reasonable regulation, it can help keep the human herd safe.
http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin
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Jon Rynn Posted 5:20 am
28 Feb 2009
The problem is that competition pushes financial firms to push the accelerator on speculative and clearly imbecilic strategies for the long-term, because in the short and medium-term, the strategies work. If I am a financial firm and I don't use these strategies (such as subprime mortgages, for instance), then the firms that do use thsoe strategies make big bucks. It's not just that I don't make as much money, it's that my very existence is threatened because I can be bought out or my clients will look at the guys who are doing the stupid but more lucrative things and go with them.
This isn't such a problem in the rest of the economy. if yoou make widgets and everyone wants them and you overexpand and noone wants pet rocks or whatever anymore, you might go bust but you won't bring the whole system down.
So the only real way to deal with this is to seriously cut back on financial instruments like derivatives, to cut out most "financial engineering", and to sit on the financial system and make sure that basically all that they are doing is lending money for productive uses.
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