For a policy that is supposed to save the planet, there is surprisingly little public debate about carbon trading. The principle of buying and selling permits to emit greenhouse gases now dominates international thinking on climate change. The government’s recent energy review confirmed that carbon trading “will remain the central element of the UK’s emissions reductions policy framework,” a view strongly endorsed by the Stern review. The idea of nations trading emissions also lies at the heart of the Kyoto protocol. Carbon markets in some form exist across Europe, Japan and even in parts of the US and Australia. And while carbon trading has so far been the domain of big power companies and heavy industry, in future we may see schemes involving supermarkets, local government and even individual citizens.
Yet economists aside, most people have little interest in carbon markets. Since the subject is full of acronyms and obscure jargon like “grandfathering,” “bubbles” and “flexible mechanisms,” this state of affairs is understandable if undesirable. Given the urgency of the climate change issue, it is crucial that the policies we design to mitigate it are effective, and there are some very serious questions about carbon trading. As we shall see, the devil is in the details of scheme design.
Principles of pollution trading
The basic ideas underlying carbon markets are simple. A good way to understand them is to look at the precursor to today’s carbon schemes—sulphur dioxide trading in America. In 1990, the US government set up the acid rain programme to reduce annual emissions of sulphur dioxide by 10m tons below 1980 levels, a cap that has been subsequently tightened. One way of reaching such a target is to specify that each power plant or factory must reduce emissions by a set percentage. But where it is cheaper for some polluters to make cuts than others, a tradable permits scheme can in theory achieve the same outcome at a lower cost. This is the approach of the acid rain programme. Tradable permits create a market, requiring the polluter to pay for the right to pollute. The general idea is that the total amount of pollution allowed is allocated among polluters in the form of permits, mainly in proportion to each plant’s heat output. Each permit allows the holder to emit a ton of sulphur dioxide. In the first phase of the acid rain programme, over 400 power plants in the eastern and midwestern states were included. At the end of each phase, each participant had to have the correct number of permits for its actual emissions or face a fine ($2,000 per ton).
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