August 05, 2008
Breakthrough Responds: Why Carbon Pricing Won’t Cut It
This is a response to Max Epstein's guest post, "In Defense of Carbon Pricing: Why Clean Energy RD&D Isn't Enough." Our response is written by Breakthrough Generation fellow Zach Arnold.
Before anything else, I want to thank Max for his thoughtful post. His arguments have been a big help in clarifying our own thinking.
In my response, I'm going to try to define the problem we're trying to solve, and clarify the differences I see between a carbon price driven regime (as Max advocates) and an investment-led regime (as we're more fond of at Breakthrough). I'm then going to explore the political feasibility of a carbon price, and what a politically sustainable carbon price can and can't do to address climate change. In doing so, I hope to show that, for now, we can't rely on carbon pricing to drive the shift to a clean energy economy.
The challenge ahead: developing and deploying clean energy technologies and creating a new economy
Although cap and trade advocates are fond of invoking the success of the 1990s SO2 trading program that helped cut acid rain pollution, Max recognizes that overcoming the climate and energy challenge is a wholly different undertaking. Cutting acid rain necessitated adding scrubbers - an existing, largely developed technology - onto a handful of power plants in one country. As Max rightly points out, the massive challenge ahead of us is something different entirely - nothing less than the restructuring of the global energy system, entailing a massive shift from well-established and cheap (but dirty) fossil fuel technologies to a broad suite of next-generation energy sources that, for the most part, are expensive and currently marginal. With this in mind, the question on every climate activist's mind must be: "What strategy available right now will maximize innovation and deployment of low-carbon technology?"
This is a very different question from the currently popular framing - "What strategy available right now will lead to the deepest emissions cuts?" Obviously, decreasing atmospheric concentrations of CO2 is the end goal of any climate strategy. But approaching the problem from the perspective of emissions accounting and control is just asking for trouble. Even if we could establish a perfect emissions regime here in the US, we'd have the rest of the world to contend with - and creating a globally comprehensive regime, or even persuading each country to adopt its own, would be quite a task. As another blogger has written:
Think of what it would mean to enact a harmonized global carbon tax (or some alternative regulatory scheme, even less theoretically efficient than a carbon tax). You'd have to get, among others, the French National Assembly, the Parliament of India, the Brazilian National Congress, the Chinese Politburo, and Vladimir Putin to go along. What kind of side-deals do you think would be required to get them to do this? Further, even if we got to an agreement de jure, we would then have to enforce a set of global laws for many decades that would run directly contrary to the narrow self-interest of most people currently alive on the planet. How likely do you think a rural Chinese official would be to enforce the rules on a local coal-fired power plant?
Indeed, developing countries, disinclined to risk slowing economic growth, have time and time again signaled their unwillingness to adopt hard limits on their emissions, now or in the future. In the context of such challenges, tracking, capping, and controlling the world's CO2 is a pipe dream, and certainly not an approach that promises serious reductions in the near term. Instead, our goal must be to make clean technologies as cheap as possible, enabling their deployment throughout the world regardless of the regulatory regimes in place.
Harmony in theory: investment and a carbon price work together
We've now defined the challenge as one of technological development and deployment. At this point, Max might reiterate that carbon pricing is the best way to reduce the price of low-carbon technology, because it would mobilize massive stores of private capital and direct attention to the most efficient and immediately effective technologies. And indeed, a carbon price would help greatly. It would theoretically channel private capital (which, as Max rightly points out, is quite a lot of money) into the battle, while raising funds that could then be used for public investment. Moreover, making dirty energy expensive through a carbon price would reduce the price gap between clean and dirty technology, reducing the work that strategies like subsidies, portfolio standards, and basic development would have to do in order to make clean technologies competitive.
Carbon pricing, in other words, theoretically gives you more bang for your investment buck (although this theoretical relation wouldn't always pan out in real life, as I'll explain below). This is why Breakthrough supports carbon pricing to the extent that it's politically feasible, both as a funding source for public RD&D and a driver of private investment. The question is one of emphasis: do we advocate a carbon pricing regime, supported by limited government investment where deemed strategic - or a massive public investment initiative, funded and facilitated by a modest carbon price?
This is not, as some have asserted, a frivolous or merely academic question. We need to figure out what policy vehicle has the greatest potential right now to change our energy technology complex. And many proposals have already made an implicit judgment, relying on a carbon price to do the heavy lifting and allocating comparatively little (if any) funding for investment. In the next sections, I'll argue that such judgments are deeply flawed.
Theory meets reality: the political prospects of cap-and-trade
First of all, let's get clear about the sort of carbon price that would be necessary to drive big changes. As it turns out, big changes require big prices - carbon prices far higher than anything being considered now. Over at Grist, economist Jim Barrett points out that recent price increases in gasoline - roughly equivalent to the imposition of a $200/ton CO2 tax - have decreased driving by only about 4% nationwide, and residential energy use is likely to be even more stubborn. (These are the two largest sources of American CO2 emissions). Meanwhile, in order to make solar photovoltaics cost-competitive with coal (to cite one example), we'd need a CO2 price of $220/ton. These are prices that far exceed any current carbon price, as well as those projected or mandated under any existing proposal.
But even if high prices are necessary, Max might object, we could make them politically doable by taking some of the proceeds (obtained by government sale of permits) and giving them back to consumers. The idea is that "cap-and-dividend" can make carbon pricing acceptable to the average Joe by cutting him a check to cover or even exceed his losses due to higher energy prices.
Unfortunately, crafting a politically feasible proposal is not just a matter of "running the numbers" (as Max says). Cap-and-dividend fails to address the "pocketbook" anxieties that have sunk and will continue to sink carbon pricing proposals. For one thing, it's not at all clear that under carbon pricing, dividends will cover the losses to each consumer. Max chooses EIA figures to back up his assertion, and those are probably as good as any (although I can't resist noting that the EIA's track record in forecasting is pretty horrible), but in fact, estimates of the consumer cost of carbon pricing range substantially higher. For example, Barrett (whose organization runs its own economic models) puts the annual per-household cost of a $50/ton CO2 tax at $1000, not $30-325. And remember that $50/ton CO2 might not even do much; what happens at $200/ton is anyone's guess. Asking Americans to have faith that these ominous and highly uncertain dynamics of cost and benefit - overseen by the government, everyone's favorite redistributor of wealth - will eventually work out in their favor is a recipe for political failure.
In addition to these threatening uncertainties, cap-and-dividend has some very certain - and very disturbing - equity implications to deal with. Discussing the economic pain of carbon pricing in terms of per-household cost is misleading, because pricing CO2 will have a highly uneven effect across the American economy. Some people will pay a much greater price than others - for example, rural Americans who rely more on driving, or people whose utilities rely more on coal power (e.g., the entire Rust Belt, including some rather important swing states). The overall effect is likely to be a wealth transfer from one group of Americans to another. Barring the construction of a complicated and politically fraught apparatus to distribute dividends based on per-capita carbon reliance, I don't see any way to deal with this problem.
And while the costs will be limited to higher fuel prices and electricity bills for some, others will lose their jobs, as those firms already in dire straits get pushed over the edge - e.g., the manufacturing sector, which the EIA projects will be disproportionately impacted. In this way, implementing cap-and-trade with dividends is likely to bring back the same sort of debate that flared around outsourcing years ago; as in free trade, for each citizen, the benefits of cap-and-dividend will be diffuse (although considerably less certain than those of free trade), and the losses concentrated and highly visible.
In the near term, these dynamics are likely to keep the Gordian Knot as tangled as ever. That is, the only way that a cap-and-trade bill will be passed in the foreseeable future is with substantial cost-containment measures, effectively diminishing the price incentive and hamstringing the regime's impact on technological innovation and deployment. And even with such measures, passing Lieberman-Warner II (or whatever it may be) isn't exactly a safe bet. Keep in mind that L-W, even with billions upon billions in handouts, substantial permit giveaways, and other cost-containment measures, collapsed pretty quickly in the Senate.
Reality, part II: trouble in the market
But carbon pricing doesn't merely face political problems. "Market-driven solutions" like cap-and-trade are also subject to myriad market inefficiencies and inelasticities. Max highlights a few of these, but the fact is, these troublesome dynamics are everywhere. A wide variety of factors, of which price is one, influence people's decision making about how much energy they'll consume, or what sort of car, factory, or power plant they want to buy - so in most cases, simply nudging the prices in play isn't enough.
Generally, the phenomena I'm referring to are known as "market failures" - situations where, for one reason or another, people or firms don't make decisions that would be a net positive for society - or even for their own pocketbooks. These are extremely common in the areas near and dear to energy policymakers' hearts. After all (to cite one example), if people made decisions based simply on overall cost vs. benefit, then every house in America would already be outfitted with a solar water heater and decent insulation - measures that are already profitable for both individual actors and society at large, even without a carbon price. Or consider the serious dearth of energy research - total basic energy R&D in the U.S. is less than the R&D budget of one biotech company.
Market failures like these have a million causes, which perhaps explains why most cap-and-trade advocates tend to avoid talking about them beyond a generic "the government should fix them." However, not only do carbon-price proposals generally not seek to "fix them," but these failures are far more widespread than most admit.
Take electricity production, for example. As a recent article on this subject opined, "Ultimately, the belief that prices alone will solve the climate problem is rooted in the fiction that investors in large-scale and long-lived energy infrastructures sit on a fence waiting for higher carbon prices to tip their decisions." Investors in power plants aren't likely to choose clean options (cogeneration, renewables, even natural gas) if there's uncertainty over the future price of carbon, or over the lifetime emissions of a proposed project. Moreover, insufficient public infrastructure (like transmission lines) and human capital (solar installers, wind turbine technicians) often obstruct clean energy development.
There's also pervasive inelasticities in the areas that carbon pricing targets. As I alluded to before, heating and transportation - which together account for over half of American emissions - have really inelastic demand, meaning that big price hikes don't translate to big changes in behavior. People drive and heat their homes because they have to, not because it's affordable.
Some of these dynamics (e.g., inelasticity) can't be changed through policy, making a carbon price somewhat irrelevant in those instances. But most market failures can. However, if legislation doesn't address a fair few of them (and I'm not aware of an existing carbon price proposal that does), then the impact of a carbon price could be seriously compromised. Were the levels of CO2 pricing currently being thrown around in legislative proposals (low double digits per ton) to be implemented directly, via a carbon tax or cap-and-trade "safety valve" mechanism, we might achieve the worst of both worlds - real financial costs to consumers, but little change in emissions. On the other hand, if the government stood firmly by the principles of cap-and-trade, limited overall emissions, and allowed the market to set its carbon price autonomously, the presence of failures would drive the price up higher and higher, bringing us back to a tricky political problem likely to result in the weakening of the regime.
Market failures don't invalidate the idea of carbon pricing per se - any energy policy will have to take them on. However, they do demonstrate that it would be unwise to focus excessively on pricing as a panacea. Max writes, "The government should stick to targets and let the market figure out how to achieve them. Government action should be targeted to address specific market failures." But when you consider the vast array of dynamics (including, but not limited to, classical market failures) that conspire to limit the impact of a carbon price, it becomes clear that a wide variety of government interventions will be necessary, and not simply a quick fix tacked on here and there. And if these interventions aren't made, as I discussed above, big problems materialize.
Pursuing a cap-and-trade-led regime today would entail taking a massive political risk. The payoff, were it to materialize, would be a complicated regulatory regime, one whose efficacy would require costs far above the realm of the politically possible - making it an instant non-starter.
You'll forgive me for being underwhelmed.
Max is right to point out that the challenge we aim to tackle is vast, and we're going to need all the tools we can get to take it on. Would an ideally administered, quickly implemented, high carbon price (supported by various complementary policies) be a good tool to have? Sure. But debating idealized policies doesn't help anything. In the real world, the American polity and the American market are not ready for a tough carbon price. With this in mind, the proper response is not to continue to advocate an unimplementable strategy. Instead, we believe that the best way to respond to the climate challenge right now is to massively expand the role of the federal government in researching, developing, and deploying clean technology.
Unlike cap-and-trade, such a strategy is politically ; Americans are eager for an energy initiative based not on limits and regulation, but on large-scale investment and a public push for energy independence. With energy prices at the top of Americans' concerns, a policy focused on providing new, clean and affordable energy sources - rather than pricing our way to greenhouse gas emissions reductions - would stand on significantly stronger political footing.
And importantly, this strategy isn't a simple compromise, or a capitulation to the prevailing political winds. Government action can spark real change - and in fact, it always has. Stepping up public involvement to such a degree is often dismissed as "picking winners" - substituting the imperfect expertise of the government for the invisible hand of the market. However, leaving the very real imperfections of the market (not to mention every extant cap-and-trade proposal) aside, history indicates that the government can and almost always does play a key role in technological transition. From R&D support for civil aviation, lasers, and software to the demonstration and deployment of technologies like computer networks and modern wind turbines, direct public intervention has been essential over the past century - in every step of the development process, not simply basic research.
(As an aside: it's interesting that Max brings up the PC revolution in this context. While the U.S. government might not have subsidized the IBM 5150 (as Max dryly observes), it actually did buy copious amounts of early microchips, leading to a precipitous decline in per-unit cost and fueling the development of today's semiconductor and personal computer industries. Government deployment strategy at work!)
It's time to embrace the role the government can play. There's no doubt that a government-led investment strategy comes with many problems of its own. We are aware, for example, that public investment and continuing subsidies have all too effectively created mature fossil fuel and corn ethanol industries. But a well-designed, investment-centered policy - a policy that mobilizes public and private capital through direct funding and indirect incentives, addresses pervasive market failures, and inspires Americans to help create our new energy future - has the potential to be truly transformative. We're still working through the details of what such a policy looks like, and we'd love the help of other policy and political minds. But for now, given the circumstances of our time and the nature of the challenge we face, we're confident that this is the direction to choose.