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Free Market Strategies to Confront Global Warming


The debate is over

Challenges to the Economic Approach:

The Case for Market Intervention

 Free Market Strategies

Carbon Taxes

Emissions trading: Cap and Trade
-Setting the Cap
-How are they distributed?
-Case Study: SO2 emissions
-Case Study: Kyoto Protocol

Economic Adaptation

Further Information

Comments & questions to:

Emissions trading: Cap and Trade

    Cap and trade is an emissions trading scheme where the total allowable amount is capped, permits are issued and then can be traded freely .  The most important aspect of emissions trading is that it limits the total amount of emissions and lets the market decide where and how the reductions occur.  Emissions trading schemes can therefore easily be attached to a politically determined emissions reduction plan.  Emissions trading are not new; it was used in the 1980s to phase out leaded gas and CFC’s .  They also has a very high level of flexibility.  In many ways they are like stocks because each permit carries the right to emit a certain amount of carbon dioxide and this can be traded.  A limited amount of permits are issued, but they can be traded after that or bought in one year and used in another.  The advantage to permits is that they work like many other markets today and have high flexibility.

Setting the Cap
    Setting a good cap for total emissions is critical for an efficient outcome.  While setting the cap on carbon emissions is an issue of scientific and political decisions, as well as economic, permit trading fits easily with set goals.  A carbon tax, on the other hand, must rely on market analyses to determine appropriate pricing and would need to be adjusted many times.  Emissions permit systems, however, lose momentum when they go beyond their goals for emissions reduction.  If emission reductions are made beyond the target, the price of permits will drop, decreasing the economic incentives to continue reducing.  Carbon taxes do not suffer from this weakness since they offer a continuous incentive to reduce emissions.
How are they distributed?
    A major contention point with emissions trading schemes is the determination of who gets them and how they are distributed.  In a fully free market, emissions permits would be auctioned off to all emitters.  However, this is often not the case.  Preferential treatment of different permit buyers can mean that some companies can have early access to permits before others.  This system runs the risk of rewarding companies for their “connections” and not their emission reductions, as was originally intended.  So far, permits have not been auctioned, but rationed out for free based on past emissions.  This allows for an easier transition to the trading market, after which the number of permits decreases to create reductions.  This system of “grandfathering” permits can penalize companies who have already made emissions reductions in the past.  If a company is highly inefficient, making significant cuts is easy at first, but as cuts increase, the cost increases for comparable reductions.  If a company has been responsible in the past and then is transitioned to a permit system, it will not recognize or reward past actions and make it relatively harder for that company in the future.

Case Study: SO2 Emissions

"it would be imprudent to forget how lengthy and heated the national dialogue was over capping SO2 emissions, allocating allowances, and adopting a market based approach. "

    S02 emissions trading program grew out of growing concerns over acid rain and was implemented under a section of the Clean Air Act amendments in 1990.  The system concerned itself with the worst offenders; over 100 coal burning power plants all over the country.  The system was implemented in two phases, after first including the initial plants, in included an opt-in clause that would allow other emitters of SO2 to join in the trading market.  The market freely allocated permits and allowed for trade.  Trading took a while to occur and at its highest, only 2.7% of permits were traded  and many of them within companies.  However, the system was largely a success and indicated a greater than expected decrease in costs to decrease emissions.  Significant effort went into implementing the system and with great opposition.  In the end, the political will to address the problem pushed its implementation and the evidence indicates that it allowed for reductions at much lower cost than a law might have. 
"Despite these and other uncertainties, market-based instruments for environmental protection-and, in particular, tradeable permit systems-now enjoy proven successes in reducing pollution at low cost.” -Robert N. Stavins

Case Study: Kyoto Protocol
"the Kyoto Protocol, a deeply flawed agreement that manages to be both economically inefficient and politically impractical."

"In March 2001 the U.S. under President Bush declared its withdrawal from the Protocol, reasoning that the costs to the U.S. economy would be too high and exemption of developing countries from binding emission targets would not be acceptable"

    The Kyoto Protocol is a program originating from a series of international conferences that created emissions targets for developed countries.  It entered into force in 2005 with the entry of Russia into the scheme and began to work towards its goal of reducing total emissions 5% below 1990 emissions by 2012.  Kyoto has been highly criticized by those who believe it has gone too far, not enough or that it is just plain impractical.  Emissions targets vary by country and have been criticized for being little more than arbitrary numbers related to politics.  The trading scheme is grandfathered based on emissions in 1990 and creates some strange situations.  For example, Russia, which suffered from an economic collapse since 1990 has a huge excess of permits to sell, effectively being rewarded, even though they made conscious effort to reduce emissions.  Because of this and many other reasons, the Kyoto protocol has been contentious for years.  The fact that the protocol excludes developing countries, has been the stated reason why the George W. Bush has refused to sign it.  The protocol, however, is a product of the political processes that created it.  It is symbolically important because it is the first agreement of its kind, but it also indicates that many countries do not yet take the problem of global warming seriously.

Last updated:  2/2/2006


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