THE RISKS OF CLIMATE POLICY

September 12th, 2007 <-- by Paul Higgins -->

This post identifies real and perceived risks of climate policy and explores ways to minimize those risks. I’ll focus on four risks:

1) Damage to the economy as a whole
2) Damage to some sectors within the economy
3) Lost opportunities from the investment of limited resources on climate change
4) Potential political costs of supporting climate policy

Most risks, perceived & real, can be managed well but not all can be eliminated entirely.

OVERAL DAMAGE TO THE US ECONOMY: Economic damage can occur if policies to curb greenhouse gas (GHG) emissions are either too weak or too strong. Steep emissions cuts create economic risks because they may trigger price increases for electricity and transportation. Weak policies create economic risks by increasing climate damage itself and by potentially requiring steep emission cuts in the future. An additional risk comes from unilateral action, which could reduce a nation’s competitiveness.

One solution is to begin with policies that modestly curb GHG emissions, that build our capacity for longer-term reductions, and that include powerful incentives for international cooperation. Most of the existing legislative proposals in the US seek relatively modest near-term curbs on emissions and use market-based approaches to keep compliance costs to a minimum. These approaches, combined with incentives for international cooperation, would greatly reduce the potential for large economy-wide damages. Indeed, including the cost of climate damage into the price of activities that lead to GHG emissions is an overall economic benefit because it reduces the damaging subsidy that comes from being able to use the atmosphere like a free sewer.

DAMAGE TO SOME BUSINESSES OR ECONOMIC SECTORS: This risk is very real. In general, policies that internalize the societal costs of pollution will benefit the population as a whole by protecting the climate system, promoting greater efficiency among existing businesses, and creating new business opportunities (discussed here). However, some existing individuals, corporations, and economic sectors will be hurt by climate policies. Those most likely to be hurt are the fossil fuel producers (especially coal), coal-fired electricity generators, heavy energy consumers (e.g., manufacturers), and, if we aren’t careful, low-income families.

One solution is to distribute some of the economy-wide gains we can expect to those who get hurt. For a CAP-and-TRADE approach, this is accomplished by giving permits freely to disaffected groups. Economic analysis suggests that far less than half of the permits are needed to compensate those who are badly impacted. There will still be winners and losers, however, so it is not possible to completely eliminate this problem.

LOST OPPORTUNITY FROM THE INVESTMENT OF LIMITED RESOURCES ON CLIMATE CHANGE: This is a legitimate concern for climate spending but not for market based climate policies that put a price on pollution (i.e., CAP-and-TRADE or EMISSION FEE approaches). Federal dollars invested to reduce GHG emissions could be used in other ways that advance the public interest (e.g., child health and welfare, education and job training, health care, basic research, decreasing the deficit, etc.). In some cases, the return on federal investment may be larger if spent elsewhere.

One solution is to enact only legislation that internalizes the societal costs of GHG emissions (from climate damage), without including new spending. This can be accomplished with economic efficiency using either a CAP-and-TRADE or a POLLUTION-FEE approach (which we’ve discussed here, here, here, and here). Societal costs are not well quantified, however, so it is necessary to pick a cap level or pollution fee that may be too strong or too weak. Most of the existing legislative proposals seek relatively modest near-term curbs and are therefore not likely to be too strong. As long as the internalized cost is equal to or less than the actual social cost of polluting, there would be an overall economic improvement from climate policy.

POTENTIAL POLITICAL COSTS OF SUPPORTING CLIMATE POLICY: Those who may be hurt by climate legislation generally know it, are powerful, and are well organized. Those who will benefit from climate legislation often do not realize it, are interested in a wide-range of other issues, are not very organized, and are generally less powerful. As a result, there are substantial political risks in supporting climate policy. Furthermore, some voters view climate change as a bogus ploy to push a liberal, or anti-US agenda. This sentiment appears to be waning as many businesses, conservatives, and conservative religious leaders support climate protection. Nevertheless, the real risks posed by climate change do little to reduce the political damages that could result from that perception.

One solution is to ensure that legislation eases the burden on disaffected constituencies, clearly benefits other constituencies, and promotes ancillary outcomes that are broadly favored. In a mandatory CAP-and-TRADE system, the allocation of emissions permits is one powerful approach for this as the permits created will have a substantial value. Economic analysis suggests that a substantial fraction will be available even if we first protect the profits of existing emitters. The remainder could be allocated to states based on their historical emissions and used for related purposes (e.g., improved energy efficiency, or the development of new technology) or otherwise broadly beneficial policy like education and job training.

3 Responses to “THE RISKS OF CLIMATE POLICY”

  1. David B. Benson Says:

    I recommend exploring biocoal, made from biomass via hydrothermal carbonization. For example, Biopact has an article about a biocoal pilot facility in Drenthe Province, The Netherlands, which will produce 75,000 tonnes of biocoal from forest operation wastes per year.

    I assume that this biocoal is to be sold to facilities currently burning coal, possibly including electric generating stations. Biocoal is a slightly superior fuel (fewer VOCs, no heavy metals) and can be used in existing coal reactors with no modifications and minor adjustments to operations.

    The point is that electric power producers should welcome this source of fuel, so long as it is price competitive with fossil coal.

    What about the coal mining companies? Well, I suggest producing enough extra biocoal that the government can pay those companies to sequester the coal in abandoned mines and carbon landfills. Since their income remains the same, they should have no serious objection to switching from extraction to sequestration.

  2. Albert Klyne Says:

    I am looking for information, Equipment, manufactures of Biocoal from wood waste Forestry and urban

  3. Robyn Says:

    Higgins raises a crucial point in discussing the economic risks to carbon-intensive industries in the United States and elsewhere. Fossil-fuel producers, coal-fired power plants, traditional energy companies, and other heavy industry actors stand to lose a lot and, unsurprisingly, currently represent the staunchest opponents of carbon dioxide emission reduction legislation. It is in their best interest to keep carbon from being regulated, whether by federal legislation or a market-based system. The systematic mis-information campaign by ExxonMobil during the 1990s (and still ongoing?) is a classic example of the interference leveraged by powerful vested interests. A comprehensive emissions reduction policy needs to remove the impediment they pose to climate legislation, but cannot give them special exemptions. We need to hold them accountable for the role they have historically played as climate contrarians and the nation’s largest unitary emitters, and we need to get them to reduce their emissions as soon as possible. I am uneasy about the proposal to:

    “distribute some of the economy-wide gains we can expect to those who get hurt. For a CAP-and-TRADE approach, this is accomplished by giving permits freely to disaffected groups. Economic analysis suggests that far less than half of the permits are needed to compensate those who are badly impacted.” (see above)

    If this sentence advocates giving away credits to carbon-intensive industry, the market system will be crippled from time zero. Experience in Europe has shown that credits should be auctioned from the beginning, or else different recipients stand to reap windfall profits from mis-allocation of credits. Giving away half of the credits for free would destroy the efficiency of market allocation. The invisible hand of the market must be allowed to function, and by auctioning the credits- including to the carbon-intensive sectors- we will be able to achieve the scarcity that is crucial to a well-functioning carbon trading market.

    Power generation is responsible for a large portion of America’s CO2 emissions, and any cap-and-trade system must be aimed primarily at limiting emissions from these facilities. I find it difficult to call them a “disaffected group” (see above): they have actively campaigned to keep climate change off the national agenda! Vindictive punishment is fruitless, but a coherent, consistent policy must address the cumulative emissions of this sector.

    Another argument against free credits is that if these industries are given special exemptions to ease the economic shock to their industry, they will be much less likely to invest in R&D to develop new, cleaner technologies. An article by Nemet and Kammen published in Energy Policy No. 35 (2007) revealed that the private energy sector invested only 0.23% of its revenues in R&D between 1988 and 2003, down from 1.1% (peak of 1.4%) during the period 1975-1987 (Nemet and Kammen 752). Evidently, a price shock can spur the industry to innovate, but left to its own devices its record is not too impressive. Where is this revenue going? I suspect to the shareholders and CEO benefits. But that’s another story…

    I believe that a strong cap on carbon dioxide emissions will jumpstart the R&D machine in the private energy industry, but even if it doesn’t the money is obviously there to purchase credits. Purchasing credits is not a strategic long-term investment decision, but it could pad the transition until the R&D machine kicks into gear- or the renewable energy industry overtakes them. The American private sector as a whole invests 2.6% of its revenues in R&D, and even an increase in energy R&D by an order of magnitude would leave the private energy sector behind the national curve (Nemet and Kammen 752). Why has the energy industry chosen to invest so little in R&D and new innovation? Is it really that confident that it won’t be required to reduce its carbon footprint? This misperception must change. It is time to send a strong regulatory signal to kickstart a transition to a new carbon-neutral economy. A cap-and-trade market with an auction-based allocation system would be a good start.

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