Emissions trading objections

In my (admittedly limited) reading about the proposed emissions trading scheme here in Australia, I get the impression there’s two primary objections (mostly from business, but also the opposition party – coincidence?) to the trading scheme.

The first is that a scheme will raise prices for the Australian public for goods from high-emissions industries, like electricity. I suspect this is to raise public opposition to the scheme, but I think that we’ve mostly overcome this objection.

The second seems to be that the scheme will negatively impact exports for these products, which in Australia will have a significant impact on exports. An extension to this argument is that producers in countries that don’t have such impediments will be able to undercut the price of Australian companies’ produce.

Over the jump I’ve put together some initial thoughts on these objections and the Government’s proposed approach…

(First a disclaimer – I haven’t studied politics, economics or carbon trading – so my ignorance of these issues might show through in the following comments. However, I wanted to post them to get my own thoughts clearer, but also in in the hope that some more learned folks might be able to fill in any gaps and improve my understanding of the issues and approaches.)

Local prices

To my mind, the answer to the first objection is to provide gradually decreasing concessions to consumers of these products in the early years while companies adjust their offerings to greener alternatives. My thinking is that by targeting these concessions at consumers, competition among companies will occur sooner as companies that take early mover advantage will benefit from higher market prices and emissions-trading benefits for investments made during the adjustment period.

If such concessions were directed at the company level, I see less incentive for businesses to innovate, as they won’t receive any immediate benefit for doing so. (This assertion is based on a layman’s understanding of economics – I’d be interested in hearing from anyone with a deeper understanding.)

Let me provide two contrasting examples to illustrate my point:

Concessions to consumers

Company A and Company B both start with the same emissions output. The government puts in place a permits scheme where both companies have to pay for the emissions they produce, and they (naturally) pass this cost onto consumers. To offset this increased cost, the government subsidises the consumers through tax concessions or some form of rebate scheme, reducing the concession over time until eventually the full cost is borne by the consumer.

In a competitive market, the prices charged by Company A and B would be comparable. So if, say, Company B introduces an innovation that reduces their emissions (and therefore creates emissions permits that can be traded for $$) sooner than Company B, they can continue to charge the higher market rate to consumers – effectively cashing in twice (once through traded permits, and again through charging higher prices). If they are able to introduce these innovations in a manner that also reduces their operating cost over time there is a third incentive for innovation.

As the industry adapts, this competitive advantage is reduced returning to comodity pricing, but we’ll have more sustainable technologies in use – the primary aim of the trading scheme.

Concessions for industry

If, however, the concessions are leveled at the company level in the form of “free” permits as proposed by the Government, there is little incentive for individual companies to change their behaviour early. Whilst companies that do make the investment or innovate can trade the certificates, most companies that would be interested in trading have also received free permits so there is a limited (or deflated) market for the permits.

Using the same example: Company A and Company B both start with the same emissions output. The Government grants both companies free permits to a total of 90% of their emissions (charging for 10%) and reduce this concession over a number of years. Consumers are presumably charged incrementally higher prices as the concession reduces (and additional costs charged by the companies increases accordingly) over time.

If Company B reduces emissions quickly they can trade with other companies the permits they’ve received, pocketing the $$. However, as most other companies in emissions-intensive industries have also received free permits, the market is less competitive. (In the longer-term if companies don’t reduce their emissions the market will grow more competitive as they scramble to purchase cheaper permits on the market. But initially it will be less competitive to my interpretation.)

If many companies in the market are slow to move to reduce emissions (given they’re not paying much for the privilege of emitting) the costs of retooling are unfairly borne by early movers – i.e. they have to increase their prices while others in the market remain stagnant with little opportunity to recoup investment through the emissions-trading market, creating a temporary advantage for the laggards – the opposite result to the consumer-concession model where early movers receive the early benefits.

It strikes me that this model simply serves to delay action. Perhaps I’m missing something?

International competitiveness

Both of these models address the first issue outlined at the start of this post – that is domestic demand for emissions-intensive products. But it’s clear that many of the emissions-intensive industries are export-driven, which presents a dilemma.

The most common objection I’ve seen on these grounds is that a company in another country that does not have emissions-related levys (either through taxes or trading schemes) can undercut companies from countries that do apply such charges. This would adversely affect exports.

Note that this argument doesn’t look at exporters in other countries supplying the domestic market – the WTO has indicated that Governments may apply duties to imported goods that do not have the same burden as local industries on the grounds of environmental protection (a very good bit of news I might add) – more on this from Paul Krugman (1, 2).

But if those industries are competing on the international market for export sales, non-levied companies can still undercut Australian corporations, reducing our export performance.

I have to admit that I’ve not seen any adequate commentary on how this likely outcome would be best addressed – but I suspect this is where concessions provided directly to business make more sense, economically speaking.

Given the emphasis given politically, in the financial markets, and subsequently in the media, on our resources exports, I wonder if there are measures other than concessions direct to companies that would help offset the short-term hit to exports? Does anyone have more ideas/experience in this area? I’d be interested to learn more…

  • In terms of international trade, another important group of “trade-exposed industries” are polluters competing with overseas imports in the domestic market, e.g. the concrete industry. But as with the export-oriented polluters, any price distortions caused by differences in international carbon pricing regimes can be smoothed out with appropriate border adjustments (like you and Krugman point out).

    As to your other points…

    I would be inclined not to support concessions for consumers as a whole, because the new carbon price signal needs to act across the economy in order to be effective. However it would certainly be good policy to provide compensation and assistance for low-income earners (who will pay a higher amount for carbon relative to their income) and for workers who lose jobs as the carbon industries wind down.

    There are many other objections to the ETS currently before parliament. For starters: the free pollution permits you mentioned in the post are to be almost exclusively allocated to the most polluting industries, thereby making the perverse incentives you describe all the more perverse. Secondly, the 5% emission reduction target proposed by the government is so laughably low that no one in Copenhagen is going to take us seriously, despite Penny Wong’s protestations about needing a CPRS in place before the COP.

    It seems clear that the polluting industries have had altogether too much influence over the shape of the proposed CPRS, and even the woefully inadequate Waxman-Markey bill in the US looks like a model of responsibility compared to what the Australian government is trying to foist on us today. Greg Combet admitted as much in a press conference last week: http://www.news.com.au/heraldsun/story/0,21985,25889451-5000117,00.html

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