Carbon Price Involves Give & Take

Australian National University’s Dr Frank Jotzo thinks he’s found a way to beat the carbon price impasse, with a strategy respond’s to each of the conflicting interest groups’ key concerns while still producing a scheme that stacks up economically and environmentally. Essentially, it involves give and take, as well as recognition of the global impact of emissions, not just Australia’s alone. His scheme also includes provision to lift the target to a 25% reduction in emissions by 2020, in response to any increase in global ambition.

Sydney Morning Herald

Ross Gittens

A way to tackle carbon and keep everybody happy March 12, 2011

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As if we needed any reminding, the latest flare-up of politicking over putting a price on carbon shows just how difficult it will be to gain sufficient community agreement to take effective action against climate change.

With a government lacking the numbers in both houses, the Greens demanding a sackcloth-and-ashes scheme and an opposition determinedly putting short-term partisan advantage ahead of the national interest, how are we to reach agreement?

Well, Dr Frank Jotzo, of the centre for climate economics and policy at the Australian National University, thinks he’s found a way. In a forthcoming paper he proposes a strategy that would respond to each of the conflicting interest groups’ key concerns while still producing a scheme that stacks up economically and environmentally.

He starts by ignoring the political parties and identifying four key constituencies. First are environmentally concerned citizens and groups. These are deeply concerned about climate change and convinced of the need to reduce domestic emissions of carbon dioxide and other greenhouse gases. They’d like to see Australia making a constructive contribution to global action.

Second are the general citizens, who accept that more needs to be done about climate change, but are concerned about the possible effect on their cost of living, thus making them vulnerable to scare campaigns.

Third is the general business community, which is only weakly engaged in the public debate because it doesn’t see climate change as a core concern. But it accepts that something must be done and sees an effective government response as a sign of commitment to reform and good government.

Fourth are emissions-intensive industries, which now seem to have accepted some form of emissions reduction policy is inevitable, but are focused on minimising the financial impacts on major emitters. The success of their lobbying resulted in the Rudd government’s emissions trading scheme granting them many free emission permits and much permit revenue.

While some of these businesses would be happy to see policy action delayed, more of them want to reduce the effect of uncertainty about policy on electricity generators’ decisions on new investments. The present hiatus creates a risk of disruption in electricity supply over coming years.

How could you come up with an arrangement that offered enough to each of those groups to achieve their support for action? Jotzo thinks the key to it is the leeway provided by a little-understood feature of the Rudd government’s scheme, or any other plausible scheme.

Australia is a relatively small open economy whose carbon reduction scheme would be part of a global collection of national schemes which, collectively, would significantly reduce global emissions. It’s the level of global emissions, not the efforts of any particular small country, which influences climate change.

Because the problem and the solution are global, the Kyoto Protocol and, no doubt, its eventual successor provide for the trading of emission permits between countries. This helps to minimise the economic cost of reducing emissions by allowing emissions to be reduced in those parts of the world where the cost of doing so is lowest.

If it’s more expensive for me to reduce my emissions than it is for you to reduce yours, let me meet my obligation by paying you to reduce yours on my behalf.

Under the Rudd government’s scheme it was always intended that Australian producers who needed permits to cover their emissions would be free to meet their obligations by purchasing emissions permits from overseas. This means the international price of emissions permits would set a ceiling for the market price of permits in our scheme.

It also means that, until the domestic price of permits reaches the international price, the domestic price and the rate at which it’s set to rise can be detached from the achievement of the target for Australia’s contribution to the reduction in global emissions.

Should the reduction in domestic emissions fall short of the target, the government can simply buy sufficient overseas permits to ensure the target is met. This decoupling allows us to phase in the carbon price – thus making it easier for firms and households to adjust to it – while still setting and achieving an ambitious target.

And this allows Jotzo to propose a strategy that ”has the potential to deliver a worthwhile long-run policy outcome while working within the major concerns and interests of the four interest groups”.

The strategy builds on last month’s agreement between the government and the Greens to set a government-determined carbon price from next July, with provision to shift to a trading-determined price over the medium to long term as international uncertainties are resolved.

The first step is to ensure that, wherever the initial carbon price is set, it should be increased over time so that the price in the medium term (from 2015 to 2020) is high enough to create confidence that Australia’s domestic emissions will begin to trend downwards within the next few years.

Remember, the expected future price of carbon is the major driver of present new investments in the assets – such as power plants, business machinery, transport infrastructure and vehicles, buildings and household appliances – that will shape future energy use and emissions.

The simplest way to achieve this is to legislate the path of the fixed price and then, once the switch is made to an emissions trading scheme, legislate the path of a minimum price below which the market price won’t be allowed to fall.

The second step is to set the initial price at a level low enough to give people confidence the short-run effects on the economy will be manageable and to give households and businesses time to adjust.

This would reassure general citizens and the two business constituencies, demonstrating that a carbon price won’t cause major economic disruption.

The third step is to ensure any assistance to emitters is tightly limited, determined by transparent rules, subject to sunset provisions and, above all, doesn’t reduce their incentive to cut their emissions.

In using the proceeds from the sale of permits, the highest priority should be compensating households – particularly low- to middle-income households – for the rise in their cost of living but, again, this must be done in a way that doesn’t reduce their incentive to cut emissions.

Finally, the scheme should include provision for the government to steepen the path of the carbon price, and lift the target to a 25 per cent reduction in emissions by 2020, in response to any increase in global ambition beyond what individual countries promised to achieve following the meeting in Copenhagen.

Ross Gittins is the economics editor

Source: www.smh.com.au