Undercover Economist

Trust me – we have a serious carbon credibility problem

My daughters (average age: four) have a serious credibility problem. “Daddy, if you read just one more story, then we’ll go to sleep.” “Mummy, if you give me a snack now, I promise I’ll eat up all my dinner.” You know what, my darlings? We just don’t believe you, so there’ll be no extra story and no snack.

Such troubles are not solely the preserve of little girls. Managers promise performance bonuses, workers do not believe them, and so the hoped-for performance does not materialise. Governments promise to keep a lid on inflation, nobody takes them seriously, and that is one of the reasons the lid comes off.

These problems have solutions. Most adults build up enough of a reputation for honesty that their promises tend to be believed. Politicians delegate inflation management to central banks, which – despite recent travails – are both more credible and more successful inflation-busters.

Yet when it comes to climate change, few people are talking about time inconsistency. They should be. I can find no reason to take seriously any government promises on the subject.

The British government has set a binding carbon emissions target for 2050. It is safe to speculate that the present cabinet will be out of office by then. Meanwhile, the government levies a reduced rate of tax on domestic heating and neither new nuclear power stations nor renewable energy look well placed to meet the UK’s short-term energy needs.

The EU has an emissions trading scheme, and a good idea it is, too. But its reputation took a knock when the price of emissions permits collapsed in 2007 because member states had flooded the market with them. Current allocations are tighter, but the farce could well be repeated in five or 10 years.

In the US, the credibility of carbon restrictions is weaker still, because people sceptical of the idea that humans cause global warming remain politically influential. And globally, the Kyoto regime expires in 2012. It has, as yet, no successor. Why should we believe that words today will mean action tomorrow? Indeed, why should we believe that action tomorrow will not be undermined by backtracking the day after that?

All this matters because anyone planning to build an energy-efficient office block, a wind farm or a nuclear power station will want to know that the project will not suddenly be undermined by a government U-turn.

One possible solution, mentioned last year in this column, is to create the climate change equivalent of a central bank. An “energy policy committee” could, like the monetary policy committee, use a narrow range of policy tools to meet targets set by parliament. Or like the UK Statistics Authority, it could act as an independent watchdog.

But ad hoc solutions are also possible. The government could auction off long-term carbon price contracts, in effect selling insurance (to the highest bidder) against the prospect that the carbon price collapses. Dieter Helm and Cameron Hepburn, two economists at Oxford University, have proposed an idea along these lines.

Another proposal, by the economists Warwick McKibbin and Peter Wilcoxen, is more informal: governments should auction off long-term permits to emit carbon dioxide – a ton a year, forever, or at least for decades. The owners of these assets would then constitute a lobby group for high and stable carbon prices. There is something Frankensteinian about the idea of manufacturing a pro-carbon-tax lobby group, but it’s a clever solution. For now, I am more concerned at how few people seem to recognise the nature of the carbon credibility problem.

Also published at ft.com.