Larry Summers on Cap-and-Trade

Larry Summers has problems with a cap-and-trade approach to reducing carbon emissions. He leaves us dangling with a promise that next month (his FT column comes out monthly) he will reveal a better alternative. But without knowing what that better alternative is, it's worth looking at his reasons for mistrusting a cap-and-trade approach.

1. A cap-and-trade approach, while binding in theory, might not be in practice.
   This is a danger, but I'm not too worried about it. Summers uses the example of the Maastricht Treaty, which broke down when it became obvious that some countries wouldn't meet the targets. But in the case of Maastricht, there wasn't a strong constituency which would lose a lot of money if the targets were allowed to lapse. A cap-and-trade system creates a whole infrastructure of exchanges and traders who are financially invested in those caps – not to mention the polluters who spend a lot of money on buying emissions rights, or who make a lot of money by cutting their emissions and selling their rights. Once that infrastructure is in place, there will be huge pressure to make sure the caps stay in place, not only from environmentally-aware voters, but also from large companies.
2. "The limited impact of Kyoto is evinced by the fact that carbon permits are now selling in the range of a negligible one euro a ton."
   It might be true that Kyoto has had a limited impact: this is reason to expand it. But it's emphatically not the case that low carbon prices are a sign that Kyoto isn't working. To the contrary, low carbon prices are what you would expect if carbon caps worked very well, and people found cheap and effective ways to reduce their carbon emissions. The reason that carbon prices are low in Europe today is because a lot of coal-fired plants went offline much more quickly than people had expected. That's good news. Carbon permits further in the future are much more expensive. Things are generally working as one would hope and expect, and what errors have been made in the past, surrounding estimates of existing pollution levels, can be fixed in the future.
3. "Carbon markets are invitations to engage in pork-barrel corporate subsidy politics on a massive scale."
   A common criticism, but a false one. If I'm a big polluter and I get allocated a hugely valuable store of emission rights, how am I supposed to be able to monetize those rights? The only way to do so is by stopping polluting – basically, I'd have to close down my plant. What Summers fails to realize here is that the assets that get handed out under a cap-and-trade scheme are offset by even bigger liabilities: no one gets more emission rights than they actually pollute. Under cap-and-trade, everybody starts off "short", even if the rights are allocated rather than auctioned.
4. "While in principle emission permits could be auctioned, in practice they are always allocated administratively."We're in the very, very early days of cap-and-trade: this kind of generalization is impossible to make with a straight face.
5. "The clean development mechanism has resulted in substantial payments for emissions reductions that would have occurred anyway or could have been achieved at negligible cost. There is even reason to think that certain industrial gas emissions may have been increased so that credit could be claimed for their abatement."
   I haven't heard the latter claim: I'd like to see Summers's evidence for it. But certainly a cap-and-trade scheme can and should be refined in order to give credits to early adopters, and to make it hard to game the system. On the other hand, the whole point of the cap-and-trade scheme is that it incentivizes people to do low-cost emissions reductions. If it achieves that, then so much the better.
6. "The most serious problem with the Kyoto framework is that it is unlikely to generate substantial changes in developing country policies... The truth about climate change policy is that developing countries are where most of the future action has to be."
   What's certain is that developing countries won't do anything unless and until the developed countries take the lead on this issue. What's more, a good global system of offsets, where developed-country polluters can claim credit for emissions reductions in the developing world, would solve some if not all of these problems. In any case, unless Summers can reveal next month a scheme which the developing world is sure to sign on to (probability: 0%), it's surely a good idea to get moving now where at least it's possible to make a start on these issues.

I do look forward to what Summers proposes next month, although it can't be a good sign that he admits at the outset that emissions reductions will be lower under his scheme, at least in the short term, than they would be under a cap-and-trade system. As a general rule, I think it's a good idea to do as much as we can, as soon as we can. "It won't solve everything, therefore we shouldn't do anything" is just a silly argument.