Why are we using market mechanisms to fight climate change?
Posted July 21, 2008on:
Over at No Right Turn, Idiot/Savant appears to view the idea of using markets to fight climate change as a touch silly. This view is captured in the following quote (here):
What’s important is that we reduce emissions now, not whether our chosen policy is perfect and cleaves to neo-liberal orthodoxy.
Now I think this skepticism of using a market mechanism stems from the way he views the issue of climate change policy, take for example this quote:
Some of these measures are almost certainly more effective than economic measures; if you want to ban deforestation, then the easiest way is to ban deforestation, not muck about with tradable certificates. Where they fall down is that they lack flexibility – its rare to want a total ban on something, and the hassle factor of thinking up all the exceptions can be significant.
I completely agree that there are times when “banning” will provide a superior outcome than trying to set a price. However, these times have to be carefully defined – they are times when the imposition of the social cost (including the fiscal cost of running the scheme!) associated with the activity would stop the market existing, and when the cost of enforcing a ban is cheaper than the cost of running a non-existent market.
Where we differ is in the goals we are trying to achieve. I am stating that the goal is to “maximise welfare” by making people pay for the whole social cost of what they are doing – the market mechanism allows us to do this. However, the goal I/S appears to allude to is “reducing emissions”. As the market mechanism will still allow emissions to be produced (in cases where people really highly value the products that are created) I/S seems to imply that such a mechanism would be sub-optimal.
However, if this is the case, shouldn’t I/S provide transparency and just say that a market mechanism is suboptimal because it maximises social welfare, which is decremental to his ultimate goal of lower carbon emissions.
Now there is another way that I/S may view the problem which would allow for welfare maximisation and state that banning is superior to a market mechanism. Fundamentally, if the government knows the quantity of something that should be produced the best way to do it would be to just set the quantity, rather than having a market doing it. In fact, this is sort of what they are doing with the emissions trading scheme, as they have a quantity target. I agree with I/S that the current method is far from perfect (or fair) – however, I believe that is because of too little in the way of fair market instruments, rather than too much.
Furthermore, the government does not know everything. By changing the price, but still allowing people choices, households will reveal how much they value certain things. If we can quantify the external impact of our carbon creation, then we can charge that to products – leading to the welfare maximising solution. Ultimately, the “revealed preferences” provided by this mechanism is the reason why I prefer a carbon tax (which is still a market mechanism btw) to an emissions trading scheme.
I/S writes well on a range of important environmental issues, but I think in this case his anti-market bias has gotten the best of him. We are using a market mechanism to fight climate change because it is the best way of doing it – not because of a preconceived policy bias.