Why pricing emissions isn’t enough

Climate change policy is complicated. As a general rule of thumb, anyone who says they have all the answers is at least partially wrong.

Consider recent debates over the Emissions Trading Scheme (ETS). The Climate Change Commission recommended not relying on the ETS alone to drive emissions reductions. Instead, rising prices in the ETS should be supplemented by other policies to address barriers to the low-emissions transition.

Economist Tim Hazeldine didn’t pull his punches. In the New Zealand Herald, he argued that if the ETS is sending ‘the correct price signal... then there is generally no justification for further government intervention.’ In his view, the Commission had ‘virtually ignored the substantial body of very impressive research on climate policy carried out by economists.’ His solution: to decommission the Commission.

Yet I only need to lean across my desk to disprove his point. A core textbook, The Economics and Politics of Climate Change, states: ‘in our imperfect world, a carbon price alone is inadequate, given the urgency of reducing emissions, the inertia in decision-making, and the other market imperfections’.

That was written by two of the world’s foremost climate economists, Lord Nicholas Stern and Cameron Hepburn. They conclude that ‘a carbon price is a necessary, but not a sufficient, component’ of climate policy. Overcoming market barriers and supporting technology innovation and diffusion are also critical. This view is held by many other economists who specialise in climate change.

So how is Hazeldine’s outlook so skewed? He accuses the Climate Change Commission of ‘hubris’, but, given his own unwarranted sense of certainty, it certainly begs the question.

Overseas, economists are increasingly introspective about their discipline’s role in climate change policy.

This was prompted recently by analysis of Charles River Associates, an economics consultancy that played a pivotal role in weakening, defeating, and delaying US climate policy since the late 1980s. Research funded by the US oil and gas sector was used to overplay the costs of climate action by underplaying its benefits. Indeed, the consultancy’s modelling failed to account at all for the avoided damages of climate change, nor the economic activity generated by the low-emissions transition.

Imagine a business case that includes only upfront expenses and nothing on risks and returns – and you get the drift. Former associate Paul Bernstein is on the record saying: ‘What bothers me is that our analysis just talked about the costs; we didn’t talk about the whole problem of global warming... In fact, it looks more and more like there are serious potential consequences of doing nothing.’ Nevertheless, American legislators frequently cited Charles River Associates’ research to justify inaction.

To be sure, good policy needs good economics – but bad economics can have a dangerous impact on real-world decision making. When economists are adamant that something cannot be done, we are justified to be cautious.

Consider another commentary by Matt Burgess, Senior Economist at the New Zealand Initiative, formerly Charles River Associates. He has argued repeatedly that, because the Government recently imposed a cap on units within the ETS, additional policies cannot make any difference. Taking gas-guzzling cars off the road ‘will simply free up emissions permits for somebody else to use… Overall emissions will not change.’

He is referring to the so-called ‘waterbed effect’. Squeeze it in one place, it simply bulges out elsewhere because total volume is fixed.

But let’s focus on the real world, not simple theory. The EU’s ETS has had an emissions cap for far longer than New Zealand. Actual emissions have sat beneath the cap since 2008, which wouldn’t be the case if emitters were burning through every available unit.

So where are these units going if they are not immediately being used? They are being banked in private accounts, to be sold or surrendered at a later date.

But doesn’t this mean that the underlying ‘rights to emit’ will be used in future? In other words, won’t the waterbed effect simply happen over time as units trickle back from the stockpile?

Not exactly, because the EU ETS has introduced rules to regulate the total quantity of units in the system: if too many units are being banked, then supply of new units is cut back accordingly. In the words of policy experts, the EU has ‘punctured the waterbed’.

New Zealand can, and should, do the same. The waterbed effect is a policy choice, not an inevitability.

If the Minister of Climate Change wants to accelerate the low-emissions transition and lock in the gains, he can do so by harmonising the targeted policies in the emissions reduction plan, emissions pricing and unit supply. This can mitigate the waterbed effect.

Alternatively, if the Minister of Climate Change wants to drag his heels on climate change, he could use the bogeyman of the waterbed effect as a false excuse to do nothing. Once again, bad economics would serve the purposes of delay.

It is unfortunate that wicked problems like climate change attract equally wicked solutions like the ETS. Its complexities are daunting and permit confusion and deception to flourish.

But we can focus on the task at hand. Each emission we avoid today – through behaviour change and investments in fossil-free infrastructure and technology – is an emission that won’t contribute to the build-up of greenhouse gases in the atmosphere. The more emissions we avoid sooner, the less desperate the climate crisis becomes. The ETS is a vital tool but not the only one.

Furthermore, if we prioritise decarbonising our economy, then we reduce the risks, costs and lost opportunities of delaying the low-emission transition. We also avoid displacing the problem disproportionately onto rural communities in New Zealand and elsewhere by relying on offsets from large-scale carbon-only forestry.

We need economists to illuminate, not to obfuscate, the difficult choices ahead.

Dr David Hall is Senior Lecturer in Social Sciences and Public Policy at AUT University, and served on the Technical Working Group for the Sustainable Finance Forum.

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