EU Energy Policy Blog

In Part 1 of this series explained that the Kyoto Protocol offers only two alternatives for controlling the fastest-growing half of world emissions, and neither will work. Emission caps have been rejected by the developing countries. And carbon offsets credits cost too much and waste too much to be politically feasible. Fortunately a flexible alternative that expands on the Kyoto approach just might work. …

The Kyoto Protocol is based on two principles, (1) carbon pricing is the single most efficient way to reduce carbon emissions, and (2) addressing a global externality requires an international organization to enforce mutually beneficial efforts.

CARBON PRICING was the goal of Kyoto’s emission caps and its support for trading of carbon permits. As in Europe, this would have established a uniform price for emissions, and promoted efficient reduction of emissions.

But as William Nordhaus, the leading American energy/climate economist for over thirty years, has consistently pointed out, a globally-harmonized carbon tax would work just as well. In 1997, over 2,600 economists, including nine recipients of the Nobel Memorial Prize in Economics, signed the “Economists’ Statement on Climate Change,” that concludes, “The most efficient approach to slowing climate change is through … market mechanisms, such as carbon taxes or the auction of emissions permits.” Given that caps have failed at the global level, it seems unreasonable not to try the only equivalent (if not better) alternative—carbon taxes.

A GLOBAL EXTERNALITY problem, such as climate change, causes every nation to prefer to do almost nothing. Most of the benefit of individual action accrues to others. This problem is far more serious than environmentalists commonly suppose, perhaps because they themselves are willing to sacrifice for the common good.

What we must create is a effective climate cartel. Nations must individually reduce their demand for carbon emissions—which cuts against their self interest—in order to collectively profit from a better climate. Cartels have been studied extensively, and we know what happens to them. They fall apart. Their only hope is to have one strong member who can punish those in the cartel who cheat, for example, Saudi Arabia in the OPEC cartel. But after 40 years, Saudi Arabia is still not very effective in its role.

Fortunately, a climate cartel has an advantage that normal cartels lack. An international organization, with the stature of the United Nations Framework Convention on Climate Change could impose trade sanctions on those who violate an international climate agreement. (I explain the precedent for this in Carbonomics.)

But trade sanctions are a last resort and should be used only in extreme cases. The primary basis of cooperation must be some common measure that can be readily agreed. Cartels use one of two approaches—they use price fixing or they agree to production quotas (which are just caps). First OPEC tried price fixing, but its members found it too easy to hide the price and cheat. After that failed in 1985, they got the major oil companies (which profit from OPEC’s success), and eventually the IEA, to help them monitor their production. That has allowed them to shift to production caps/quotas. Both systems work in theory, and the choice must be made according to which approach is easier to organize and enforce.

But the most important point to remember is that to fix climate change we must get most nations to act against their own self interests and for the common good—just like a cartel. This was the point of the Kyoto process and it is still the only approach worth pursuing.

FLEXIBLE CARBON PRICING. In theory the climate cartel could use emission caps or it could fix the price of emissions with a tax. Since the E.U. has implemented a cap, but developing countries reject caps, only one possibility remains: Flexible Global Carbon Pricing. This approach allows any country to meet its commitment to the Copenhagen Protocol by pricing carbon with a cap, with a tax, or with any combination of the two. In Part 3, I will explain how this would work.

POSTSCRIPT: THE FIRST CLIMATE CARTEL. Those who enjoy history, may wish read about the first climate cartel in chapter 13 of Carbonomics. Like the Kyoto Protocol, the first idea was to base commitments on quantities. This failed. After a few months of study, the concept of internationally harmonized carbon taxes was discovered, but since only oil was then of concern, they call this a domestic floor price for oil. All 17 member nations agreed to the same floor price in order to reduce their use of oil carbon. This “consumers’ cartel” was organized by Henry Kissinger in 1974, and was called the International Energy Agency. You may have heard of it. Fortunately for the climate, OPEC was stronger than this rather weak cartel, and in 1979 OPEC raised the carbon price to a high level. This proved to be a vastly more effective climate policy than anything yet contemplated under the U.N. Climate Framework. OPEC’s carbon pricing is the only policy that has ever working on a scale that’s visible in global statistics. Of course if all carbon had been priced and not just oil carbon it would have worked even better. And if the IEA countries had taxed their own carbon with a high “floor price,” instead of letting OPEC tax it, they would have saved a trillion dollars.

Steven Stoft

This entry was posted on Wednesday, July 15th, 2009 at 9:57 am and is filed under Climate Change. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.