The EU Emissions Trading Scheme and the Green New Deal
Sanjay Patnaik
While the recent introduction of the Green New Deal through resolutions in the House and Senate has generated a much-needed public discussion across the political spectrum, it is striking that neither proposal includes an explicit call for instituting a carbon price. This ignores the fundamental nature of climate change as a negative externality problem. In fact, by putting a price on carbon emissions, many goals outlined by proponents of the Green Deal would naturally be achieved through market mechanisms rather than additional large-scale government programs. There are basically two ways to do so: carbon taxes or emissions trading (i.e. cap and trade). In this commentary, I focus on the latter.
Based on insights generated from my multi-year research projects on emissions trading around the world (in particular on the European Union Emissions Trading Scheme), I highlight the following arguments: (1) a carbon price via emissions trading is a realistic and cost-effective way to change the behavior of market participants with regard to greenhouse gas (GHG) emissions, and (2) establishing an administrative structure for emissions trading (e.g., systems for measurement, verification, compliance) is one of the most important pre-conditions for the successful implementation of low carbon policies.
Carbon Pricing: The Key to a Low-Carbon Economy
It has long been established that climate change is the ultimate example of a market failure. This implies that the behavior of market participants with regard to GHGs (e.g., consumers, companies, etc.) will hardly change unless the true costs of carbon are incorporated into economic decisions across different parts of the value chain. Once a carbon price is in place, rational and self-interested actors automatically make those choices that are more cost effective (e.g., consumers buy more fuel-efficient cars if gasoline prices are higher or firms invest in low-emissions technologies to reduce their carbon footprint).
Prior experience with the US emissions trading program for acid rain (widely considered to have been highly successful) provides strong support for this argument. It shows how pricing emissions can achieve substantial emissions reductions in a cost-effective and timely manner if regulators can overcome significant political cleavages and divisions in order to implement such policies. A Green New Deal that is aimed at realistically kick-starting the transition of our economy towards a low-carbon state, should therefore be built around emissions trading as its central component.
Building Administrative Capacity for Emissions Trading
An important pre-requisite for the successful implementation of emissions trading is the creation of an adequate administrative structure. The experience of the European Union is instructive in this regard. An effective emissions trading scheme requires – among other factors – accurate systems for the measurement and verification of emissions, efficient enforcement mechanisms, a policy design process that is resilient against corporate political strategy, an appropriate digital infrastructure to track compliance and collect and store data on all regulated firms, and a regulatory approach that is sufficiently dynamic so that it can be adjusted should any major problems arise.
Within the EU Emissions Trading Scheme, regulators faced several challenges along these dimensions, including unreliable emissions data at the start of the program, continued cyberattacks against the online emissions permit registry, corporate political efforts that were able to distort the policy to the advantage of certain interest groups, and slow-moving procedures for adjusting the regulatory framework of the EU ETS as necessary. Even despite these issues, a recent study by the OECD indicates that the EU ETS led to a 10% reduction of GHG emissions between 2005 and 2012 without negative economic effects for the regulated companies. This outcome is particularly interesting as the price for emissions permits was relatively low from 2009 onwards, suggesting that more stringent emissions caps (and hence a higher carbon price) could likely have had an even stronger impact on emissions.
More importantly, many measures proposed in the Green New Deal seem to suggest monetary transfers from the government to different economic actors, sure to be inviting rent-seeking efforts by firms and interest groups that can distort the policies in socially inefficient ways. While similar rent-seeking risks exist with emissions trading, they can be more easily circumvented by transitioning from free allowance allocations to auctioning off emissions permits. By focusing largely on emissions trading, as California, Oregon and NE Eastern states are doing, rather than on too many ancillary policies, and by taking sufficient measures to safeguard against rent-seeking efforts, a Green New Deal would be more streamlined and hence more effective.
Reaching the Goals of the Green New Deal through Emission Trading
A major advantage of emissions trading is that it works through the market process. Instead of subsidizing sustainable farms, pricing greenhouse gases would make products from less sustainable (i.e., more emissions intensive) farms more expensive and therefore less competitive. Similarly, projects to remove GHGs from the atmosphere will become financially attractive if they can help emitters offset their emissions more cheaply than the prevalent carbon price they have to pay to buy emissions permits on the market. In sum, while the Green New Deal proposals represent important starting points for a necessary public discussion on how to address climate change, they would greatly benefit from a more focused approach that distills the policies down to the essential core element: pricing the emissions of GHGs.
Sanjay Patnaik is an Assistant Professor of Strategic Management and Public Policy at the George Washington University School of Business.