On August 11, 2005, Ronald Bailey, reason’s science correspondent and the author of such enviro-skeptic books as Eco-Scam: The False Prophets of Environmental Apocalypse, wrote the following words at reason online: “Anyone still holding onto the idea that there is no global warming ought to hang it up. All data sets—satellite, surface, and balloon—have been pointing to rising global temperatures. In fact, they all have had upward-pointing arrows for nearly a decade.”
Although there are still plenty of free market thinkers who aren’t yet ready to “hang it up,” the center of the debate has shifted in recent years from contested science to proposed policy. And with the prospect of an anti–global warming crusader—either Barack Obama or John McCain—joining forces with a Democratic Congress carrying years of pent-up environmentalist frustration, significant new global warming regulation isn’t a matter of “if” but “how much.”
Assuming that humanity is contributing to the carbon-fueled warming of the planet, what, if anything should governments do? That question, it turns out, is just as contested among skeptics of environmental hysteria as the famous “hockey stick” graphs in Al Gore’s movie An Inconvenient Truth. So we discovered last October, when we matched Bailey on a climate change panel with Lynne Kiesling, a senior economics lecturer at Northwestern University (and former director of economic policy at the Reason Foundation) and Fred L. Smith, president and founder of the pro-market Competitive Enterprise Institute, which in 2002 published a Bailey-edited book entitled Global Warming and Other Eco-Myths.
Bailey painfully concluded that climate change “is a real problem” and reluctantly favored a tax on carbon. Kiesling pointed to the difficulty of assigning property rights to the atmosphere and tentatively came out for a “cap and trade” system of creating a market for pollution credits above a government-imposed ceiling. Smith robustly rejected both ideas in favor of private innovation. The debate, held at a reason-sponsored conference in Washington, D.C., was moderated by Matt Welch.
|Click here to watch Lynne Kiesling, Ronald Bailey and Fred L. Smith debate climate change at the at the Reason in DC conference.|
Lynne Kiesling: From an economic perspective, the problem of climate change is twofold. First, there are incomplete and uncertain property rights in the air. It’s ludicrous to imagine us each walking around with a bubble over our heads so that we can only breathe and use the privatized air sphere around us. Second, there’s a large number of affected parties. In the limit, some would argue the entire planet is affected.
When a common-pool resource is shared by millions of diverse individuals, defining the use rights over that resource is really hard and costly. This is the kind of situation in which decentralized market processes have trouble even emerging. In this imperfect world, we’re considering two imperfect alternative policies: a carbon tax and cap and trade.
Our experience with common-pool resources, ranging from agreements to share the team of oxen in the medieval village to the development of the sulfur dioxide acid rain program in the 1990s, tells us that effective policy focuses on reducing transaction costs and better defining property rights so that private parties can engage in mutually beneficial exchange. That’s the logic behind the carbon cap-and-trade policy.
Like all policies in such a complex area, it’s got problems itself. How do you allocate carbon permits? There’s the knowledge problem: How do we know how many carbon permits is the right number? Also, as a policy instrument, it’s prone to political manipulation. Electric utilities are already seriously jockeying to make sure they’re playing a part in getting the rules written and that they’re involved in determining the allocation mechanisms if such a policy comes into place.
Another problem is that unlike with sulfur dioxide, the likely participants are really heterogeneous. When we were dealing with sulfur dioxide, it was mostly large-scale central-generation power plants, a pretty homogeneous bunch.
A carbon tax is also prone to some of these problems, particularly the knowledge problem and the political manipulation problem. The benefits to a permit market that have been shown in other situations are that defining property rights and reducing transaction costs does a better job of taking advantage of diffuse private knowledge. It’s also more likely to induce the process that’s at the foundation of economic growth, which is innovation. So I tend to come down on the side of cap and trade, although it’s not a ringing endorsement.
People are already doing this voluntarily. I encourage you to look up a group called the Chicago Climate Exchange, or CCX. CCX is a global carbon permit financial market, and it’s got a nice portfolio of instruments. They’ve got spot permit markets. They’ve starting to do futures now. The entrepreneur behind this, Richard Sandor, has also talked about doing funky derivatives. The participants got together voluntarily and negotiated to determine the number of permits that they were going to have. There were participants on both sides—carbon producers and carbon sinks—so you had this multilateral stakeholder negotiation to determine the number of permits in the market.
Finally, I think most people fail to realize that the abysmal job we do of pricing electricity contributes substantially to our energy use. The only resources that are priced as badly as electricity in our economy are highways and water.
Retail competition and choice for consumers would increase the offering of time-differentiated dynamic pricing, which shifts resource and electricity use across time. Research shows that this promotes conservation and more efficient use of electricity, increases offerings of green power to consumers who want to choose a green power option, and increases the incentives to develop and adopt technologies, such as price-responsive appliances, that enable private individuals to control their own energy use.
So the message from me is this: It’s a complicated, imperfect world, and the policies we can adopt that induce innovation and harness diffuse private knowledge will be the most effective for this long-term problem.