“Cap-and-Trade” is inefficient and gives the wrong incentives

Why did we start with Cap and Trade in the first place?
“Cap-and-Trade” seems to have been introduced because it was successful in getting sulphur emissions in the USA reduced, and possibly because it’s “not” a tax and sounds more “market economic” than a “carbon tax”.  And possibly it seems more logical to start with how much we would like to reduce emissions instead of how much it shall cost. But it’s not a good way of getting the climate change emissions reduced for two reasons: it’s unpredictable, and short-term it actually reduces the incentives to cut emissions.

Cap’n Trade gives more fluctuation in prices – which is bad bad bad
Cap and Trade means emissions permits will be traded on a a permit exchange – something which will give fluctuating prices. Price insecurity for carbon credits is costly since companies and individuals won’t be able to assess correctly how much they should invest in avoiding these costs, meaning that one might both underinvest in reducing emissions (perhaps making companies that could have survived go bust if the permit prices become high) or overinvest (causing companies developing low-emission products to go bust or lose money because the services they offer are unexpectedly overpriced vs. more carbon-intensive alternatives).

Cap’n Trade isn’t effective in encouraging green investments
Price insecurity also goes against the grain of the purpose of this initiative since humans
are naturally conservative and tend to assume things will stay as they are unless conclusive proof of the opposite is produced. Since the emissions cost is currently low the base expectation will be that this will continue – meaning no need to invest in emissions cutting technology on expectations of future cost increases.

Investments will of course increase over time, but only as carbon prices start biting and not so much based on expetations that the prices will increase. So the effects of the policy will be slower, when we want it to be fast.

Cap’n Trade can discourage firms from reducing emissions
There is also good reason for large emitters to expect free emission permits based on their
current emissions – for instance a system where 80% of an industry’s permits are distributed for free and the remainder must be bought. With this backdrop, who will be so stupid as to reduce emissions today even if it could be done for free? Much better to wait, pocket the free permits and then reduce emissions.

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