Friday’s Wall Street Journal editorial on cap and trade and the Waxman-Markey bill has prompted me to come out of the closet and say something publicly that I’ve been thinking for a couple of months: although I think that the most effective and economically efficient carbon policy is one that directly reflects the property rights issues inherent in common-pool resources, I don’t think we can, or should, trust this Congress to do the important, necessary objective institutional design to enable efficient carbon markets.
The fundamental economic problem in most environmental issues, including climate change, is ill-defined property rights. Either the inability or the unwillingness to define property rights is what creates inefficient overuse of common-pool resources.
In a complex and imperfect world, in which transaction costs are high enough and markets don’t arise organically to create opportunities to internalize these costs, we rely on collective action to create institutions to help us govern our use of common-pool resources. In general, policies that define use rights or property rights but do not stipulate how parties are to use the common-pool resource are the ones that have the best hope of coming close to dynamic efficiency. One reason that’s true is that it leaves opportunities open for entrepreneurs of all kinds to innovate and figure out novel ways to economize on the now-scarce right. When devising such policies, no bureaucrat can predict what those best responses and emergent creativity will be. These are the reasons why the EPA Acid Rain Program has been so successful at reducing sulfur dioxide emissions; defining SO2 emission rights and enabling their trade induced low-cost abaters to do so, and in many cases it took unexpected forms (including substituting low-sulfur Wyoming coal).
These are the theoretical reasons why I’ve always been inclined to prefer carbon markets over a carbon tax, despite their being indistinguishable on the blackboard. And, as I argued in this Reason panel a couple of years ago, both are prone to political manipulation, so in a non-Nirvana-fallacy, second-best sense I have argued for carbon markets because of their innovation and dynamic efficiency implications. This recent post from the New Republic’s environment blog provides a couple of good arguments for why carbon taxes won’t be any simpler or less manipulable. Even the imperfect outcome when the government sets the number of permits is a more direct reflection of the fundamental property rights problem than a Pigouvian tax would be. Of course, the collaborative process that the Chicago Climate Exchange members undertook to negotiate and determine a mutually agreeable carbon cap is the closest example we have to a full-on Coasean solution to determining these rights.
But then the past eight months happened — financial crisis, federal stimulus, and so on — and now we have the Waxman-Markey 648-page “discussion draft” climate change-focused House energy bill proposal (here’s the summary if your time and your stomach do not permit full ingestion of the complete draft). It has a renewable portfolio standard, lots of proposals to implement new building code regulations, and few specifics about designing carbon markets beyond a statement that 15% of them would be given to future participants as a political chit. Ezra Klein has a good post on this, with links, although he is more sanguine and more willing to accept incursions against individual liberty than I am. He’s also got a post on their legislative strategy that shed some light for me on my own opinion:
The American Clean Energy and Security Act of 2009 — otherwise known as the Waxman-Markey climate change bill — is not a cap and trade bill. Nor is it energy legislation. It’s not about modernizing the grid or promoting efficiency or encouraging renewables. Instead, it’s everything. Call it the Big Bill Strategy. And Waxman and Markey are perfectly explicit about this.
And, in the context of everything that’s come out of DC in the past eight months, this is where I get off the train. Congress’ bad behavior and poor decisions have finally accumulated to the point where I see them as utterly incapable of designing any kind of meaningful, transaction-cost-minimizing carbon policy. I’ve certainly become convinced that I do not trust them to design carbon markets. A carbon tax is still not a good policy, but the politicization of the potential carbon market and its bundling with other, inflexible energy policies will doom any carbon market that this Congress designs to a failure along the lines of the ridiculously over-politicized EU Emissions Trading Scheme.
While this bill is still just a House draft, the combination of the desire to leave most carbon-related items open to negotiation with the overwhelming urge to control and manage the individual decisions of millions of individuals suggests that Congress has neither the external incentives nor the internal motives to enagage in good, scientific, non-political institutional design to implement carbon markets.
So if I don’t trust them with carbon markets and I don’t advocate a tax, what do I propose? We’ve got regional markets that (after controlling for recession) are growing. The voluntary CCX market is growing both domestically and internationally (including China), adding members constantly. Other regional markets, such as RGGI and California, could over time grow along with the CCX into a set of integrated regional markets. Isn’t that how financial markets have always evolved througout human history? I’m not thrilled with that answer, but I think it’s loss-minimizing relative to the economic and environmental harm that a botched, overly-politicized federal carbon policy can induce.