Tuesday, 29 July 2008

Can Markets Stop Climate Change?

by Renfrey Clarke

Internationally as in Australia, governments that have had to promise climate change action have generally expressed a preference for market-based carbon abatement schemes, mostly of the "cap and trade" variety. But the question remains: can market mechanisms deal with a problem of such scale and urgency? Can we hope to trade our way out of our climate difficulties, in more or less painless, hands-off fashion?

Perhaps the best way to start is by reflecting on the things that markets do well. Markets historically have proven very good at mediating exchange in settings where large numbers of sellers, operating on something like an equal basis, need to strike deals with large numbers of buyers. In these circumstances, supply and demand tend to respond quickly to one another, with prices shifting to maintain a rough equilibrium.

Does this have any relevance to a market in carbon emissions? In the Rudd government's scheme, about a thousand Australian firms, responsible for about three-quarters of emissions, will be required to square their carbon accounts.

A thousand purchasers of carbon credits might seem like a large number. But in practice, the demand for carbon credits will be concentrated heavily in the hands of a tiny number of large emitters, especially electricity generators burning fossil fuels.

In theory, these consumers could embrace the system letter and spirit, purchasing the credits they need when they need them and at a fair price. There are, however, enormous inducements for the big buyers to do otherwise.

For a start, they can put extraordinary pressure on the government to simply give them credits for nothing. When the European Union first established its emissions trading system, large numbers of carbon credits were handed out free of charge to established emitters. When potential purchasers of credits eventually twigged to the oversupply, the market collapsed. Emitters were able to satisfy their legal obligations with credits bought, essentially, with money from the petty cash box. All incentive to invest in cutting emissions vanished.

In Australia, free-market economist and government advisor Ross Garnaut has argued that coal-fired power generators should have to buy all their credits at auction. But with its Green Paper, the government has dodged this fight. Electricity generators and "trade-exposed" polluters are to receive major assistance, with the latter being given as many as 90 per cent of their permits gratis. Other sectors such as the liquefied natural gas industry are now wielding the stick, trying to extract pledges of equal treatment.

The big emitters, meanwhile, are not petty stallholders on a crowded, muddy village square. They are corporations of world scale whose size gives them a dominance that no-one enjoys in the classical marketplace of the textbooks. They will face heavy penalties if found to be colluding in order to force down the prices of the credits they need, but in the wink-wink, nudge-nudge world of the carbon exchanges, such collusion will be almost impossible to prove. In any case, the very largest polluters will be able to influence prices quite independently. The mere planting of a rumour that a big power company is out of the market for a large block of credits will, at times, be enough to send prices tumbling.

Theoretically, monopoly practices and attempts at price manipulation should be less of a problem on the supply side, with large numbers of solar panel installers, forestry operators and small renewable energy companies having carbon credits to sell. But this field, too, has plenty of rotting stumps to tangle the machinery of the market.

For a start, what does a carbon credit represent? Supposedly, one tonne of avoided or sequestered emissions of carbon dioxide equivalent. But what if the sequestering is done in a forest, and the forest burns? What if the sharp-minded owner of a tract of old-growth forest decides to cut down the old timber and use the land for plantation forestry, which absorbs carbon and earns credits at an accelerated rate?

If markets are to be used to provide incentives for desirable abatement practices, while maintaining due protection for the environment, they have to be accompanied by burdensome regulation. This is because of a fundamental limitation of markets: they fit poorly with non-quantifiable criteria, such as the sustainability of a complex environment, that can be reduced to calculations of economic profit and loss only through the most bizarre mental contortions, and often in quite arbitrary fashion.

When the generating of carbon credits requires a mountain of regulation, a key theoretical advantage of markets - their relative spontaneity, efficiency, and freedom from bureaucratism - ceases to operate.

The arbitrariness introduces an especially potent danger - corruption. When government officials have to make decisions according to complex and sometimes contradictory criteria, accusations of favouritism are near-inevitable. Some officials will decide that if they are going to be accused of it, they may as well practise it - and for reward.

In Australia public officials are generally conscientious, and in any case are closely policed, but this is not true world-wide. Critiques of the nascent international carbon trading system set up under the Kyoto Protocol include hair-raising accounts of carbon scams in developing countries. The credits claimed as a result have been sold as good coin to emitters in the European Union. In Australia, the Rudd government plans to plug its carbon trading scheme into the world system as the latter assumes a more definitive shape.

The supply side of the carbon credit system, meanwhile, will not be as proof against market-rigging as might at first appear. In large part, carbon credits will not be bought directly by emitters from the firms that create them. Instead, specialised institutions will buy up the credits and resell them. In a letter to the Australian Financial Review, quoted in the July 17 Australian, former AFR editor Vic Carroll warns that financial institutions are "strong supporters of an emissions trading scheme because they [stand] to gain from trading permits and creating complex derivative markets."

The phrase "complex derivative markets" should ring alarm bells. In a parallel to the Nasdaq and sub-prime mortgage booms, vast quantities of surplus capital that race electronically across the world's time-zones looking for areas of high-profit speculative investment can be expected to alight in the new carbon credit market. Sharp practitioners will quickly devise ways to push prices in the direction they want. But as with the sub-prime crisis, the derivative markets will in time become so extraordinarily complex that no-one any longer understands just what they are or how they will respond to stimuli. A crash at some point will be an effective certainty.

If the effect of all this were simply that speculators lost their shirts, none of the rest of us would mourn. But the rationale behind carbon trading is, after all, to tilt the financial playing field so as to encourage investment in green technologies. If the price of carbon credits gyrates wildly - as can be anticipated in a speculative environment - investors will be loath to put up large sums for long-term development in areas such as renewable energy infrastructure. A Nasdaq-style crash could see carbon credits rendered near-worthless. Without the protection carbon credits afford, the renewables sector would become uncompetitive, and could expect to be wiped out.

It can, of course, be argued that if one is not too doctrinaire about free markets, regulations can be built into the system to try to ensure that its more vicious propensities are restrained. Criticising the Rudd government's ambition to launch its carbon trading scheme in 2010, Matthew Warren noted in the Australian on July 21:

"The European Union spent five years just designing its scheme and it's in the middle of seven years of phased transitions to iron out structural problems. They don't actually switch to unconditional trading of permits until 2020."

Since when, however, did humanity have until 2020 to take decisive action against climate change?

When market mechanisms are unsuited in principle to the tasks involved in combatting climate change, and when the effect of markets is to introduce high levels of additional risk and delay, why are markets set to become the backbone of world action against global warming?

The decision to rely on market mechanisms, it is fair to say, is essentially faith-based. The belief that the unfettered play of market forces reliably has better results than attempts by governments to regulate economies has a long history in capitalism. It regained ascendancy in the 1980s, after the recession and turmoil of the 1970s had discredited the earlier Keynesian orthodoxies. Most professional economists remain skeptical of the ideas of the more extreme, "neoliberal" free-marketeers. But the rationale these ideas provide for a general hostility to government regulation means that they are popular among corporate executives, especially in times of expansion. Accordingly, the more literal-minded free market economists tend to enjoy prestige and influence. And among governments which - like that of Kevin Rudd - rule with their ears trained to the sentiment in the corporate boardrooms, the recommendations of neoliberal gurus take on something of the force of holy writ.

If market mechanisms cannot serve as the key tool for stopping global warming, what should be substituted? There is no single, straightforward answer, but a carefully devised carbon tax would be useful in many settings. The list of economists - and even some business figures - who have pointed this out is growing. On July 15 noted US economist Jeffrey Sachs - ironically, one of the designers of the neoliberal "shock therapy" policies applied in Eastern Europe in the 1990s - told the ABC's 7.30 Report that he viewed an emissions tax as a simpler, cheaper alternative to carbon trading:

"It's much easier simply to tax the few places upstream - the oil, the gas, the coal, that puts on the price on carbon, then works through the economy - rather than a more complicated scheme where you monitor what thousands or even tens of thousands of individual enterprises are doing."

Taxes, however, are mostly unpopular, and governments that introduce new ones often pay heavily in political terms. Price hikes and slumps in the marketplace, by contrast, can be represented as random and impersonal. As the AFR's Vic Carroll observed in his earlier-quoted letter, "Governments prefer to hide behind markets, with all their costly excesses."

Carbon taxes are not for governments that lack political courage, or that refuse to be honest with the public about the dangers posed by climate change. Nevertheless, such taxes are much easier to bring into quick operation than emissions markets, and would be an important element in any effective greenhouse gas mitigation scheme.

Imposing a tax, however, is not the same thing as ending emissions; it merely sends a price signal that may be heeded or may not. The need to combat global warming is now too urgent for anything except highly focused action, at least in the case of the really big polluters. Indirect instruments such as taxes and market incentives are too slow, and their effects too unpredictable and diffuse, for them to be entrusted with the job.

A quite different set of measures is needed. Public ownership and concerted planning are essential in areas such as electricity generation, metals smelting, vehicle production and long-distance transport. Indispensable steps will then become possible whether corporate executives smell profits or not. The bureaucratism, delay and waste implicit in efforts to redirect market impulses using regulations and taxes will be avoided.

None of this is good news for the capitalist system. But then, global warming is not exactly good news either.

You've read the book. Here's the musical.

The Market

Let no-one think to question,

Still less to overrule

The clear calm voice of reason

From the Chicago school:

There's no way known to science

To provide for human need

Except through raids and sell-offs,

Through panic, and through greed.

The market, the market,

Its hand is sure and true;

To every teenage dope-fiend

It supplies his airplane glue.

It keeps the flint-eyed landlord

Stacking banknotes in his safe,

And gives virtuous incentives

To the widow and the waif.

Though planner preach the powers of

The human intellect,

The government that governs best

Is resolute neglect;

It lets the profit engine

Drop its clutch and charge on through

In a drag race to abundance,

Belching smoke and CO2.

The market, the market,

Its logic's there to see -

Each intricate connection

Made with such felicity!

It plies you with McTonnage

Triple fries and suchlike dross,

Then signs you up with Jenny Craig

To get the ballast off.

No charity, no mercy,

Can ease despair and pain,

So well as harnessing the drive

Of each to private gain.

With pure, health-giving snake-oil

The market treats your ills,

And while we're at it, won't you try

A bottle of these pills?

The market, the market,

The wonder-working drug -

Liabilities and deficits

Deleted with a shrug!

It cures you of distemper,

Halitosis, smelly socks,

Of botulism, bolshevism,

Rabies, and the pox.

And never let this principle

Slip lamely from your sights:

Defending market freedoms

You're defending human rights!

What point is there in liberty

Except to feed the itch

To get yourself obscenely

Individually rich?

The market, the market

Lets your talents fly the coop,

Sets you free to seize your fortune

In one delicious swoop!

Are you hitman, are you loanshark,

Is your calling hawking crack?

The market spreads before you -

Who's the piker would turn back?

The market, the market,

The perfect regimen!

So what if it feels blue

And gets depressive now and then?

Let it bloom through booms and crashes

For eons yet to come,

Through wars and through recessions,

Till equilibrium.

Renfrey Clarke 2006

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