Undercover Economist

Political ill wind blows a hole in the climate change debate

My sunny disposition is wavering as the Copenhagen summit on climate change approaches. I believe that the governments of the world have taken the wrong approach to the problem – and if they had taken a different tack 12 years ago in Kyoto, we would be much closer to dealing credibly with climate change.

The complexities are dizzying, so it may help to be reductive for a moment. The governments of the world are focusing on reducing the quantity of greenhouse gases emitted, through cap-and-trade programmes; they should instead be focusing on increasing the price polluters must pay for emissions. The incentives provided by the two approaches are similar. Both will lead to a higher carbon price and lower emissions, and both could be tweaked over time to produce much the same trajectory of lower emissions. Either system would work well from an economic perspective.

Yet politically speaking, cap-and-trade – where an agreed cap on the level of pollution permitted in a region is set, within which companies can trade those permits between themselves so long as the cap is not exceeded – has long been regarded as the easier sell. I am not convinced it deserves that reputation. There are already several technically successful cap-and-trade schemes, but none requiring anything like the political compromises now necessary. The Kyoto protocol, a quantity-based agreement on emissions, effectively died in the US long before George W. Bush became president, took eight years to come into force and could not meaningfully accommodate China, India, Indonesia or Brazil. This is hardly auspicious.

The trouble with cap-and-trade is that countries must agree how to divide the allocation of permits. This has proved troublesome when emissions targets were assigned relative to a 1990 baseline. Rapid growth in the US economy suddenly made its allocation look stingy, while the Russian allocation looked absurdly lax following the economy’s collapse in the early 1990s. It should not have been a surprise that some economies would grow faster or slower than predicted.

Gabrielle Walker and Sir David King, in their otherwise superb book on climate change, The Hot Topic, assert the conventional wisdom that cap-and-trade is politically more achievable. This statement is somewhat undermined as they start to describe the political prerequisites for such a deal, which include agreement on a global emissions cap (a hugely contentious question) and the distribution of emissions rights among countries.

There is a form of carbon tax that would be far simpler – and would not, contrary to Walker and King’s implication, be levied by the World Bank. G20 members would agree to impose a broad-based carbon tax on their own economies. The tax would be levied by national governments and spent as they saw fit. Precise harmonisation would be unnecessary. The taxes would simply need to be broadly in line, with a commitment to keep them that way.

Cameron Hepburn, co-editor of The Economics and Politics of Climate Change, points out that quantity regulation puts knotty issues of distribution and compensation at the heart of the international negotiations. Harmonised carbon taxes put these questions to one side. They could be – and would have to be – discussed separately. Perhaps a carbon tax is the wrong approach, and it is all for the best that the whole sorry mess will be on the table at Copenhagen. That is the path the world’s governments have chosen. I sincerely hope that they are right.

Also published at ft.com.