Emission trading: Fairness and efficiency

An article by Adolf Stroombergen (from Infometrics) discusses how NZ is going to meet its obligations under the Kyoto protocol.  First Adolf discusses the merits of a Pigovian tax as a way to cover our obligations.  One line I particularly enjoyed was:

“However, even if a tax has no effect on emissions, it is still fairer to put the cost of emissions on those who cause them than to put the cost on taxpayers generally.”

So damn true!  Having established what the government should do, he then goes on to discuss what they actually will do, an emissions trading system.  While a emissions trading system could, in theory, be as efficient as a tax, governments around the world have taken the strange measure of given out emissions permits for free, instead of auctioning them and using the money gained to pay off the Kyoto obligation.  The reason given for this in the article is that it is fair to compensate industries where investment has occurred only on the basis that producing carbon was free.

However, I think I see it a little differently.  If an established firm can only stay in business when carbon emissions are free, then they are socially inefficient.  So the only way the firm can stay in business is if it makes society bear some of the cost of their production decision.  That seems unfair to me.  As a result, I think that emissions permits should be auctioned by the government in almost all cases.  The only time I see scope for them to be given away for free is when we have an infant-industry, one which would be able to pay for the full cost of their production activity in the medium term.

  • rauparaha

    I agree with you in principle; however, I’m not convinced that forcing firms to bear all the costs of emitting immediately is the best way forward. Any sort of regulation needs to have some measure of public support to be viable. Forcing firms who have invested on the basis of free carbon emissions to bear the cost of those emissions is likely to result in the loss of a large number of jobs in the short-run. Avoiding this sort of seemingly catastrophic consequence is important if there is to be widespread national support for our participation in Kyoto.

    However, I would favour an auctioning off of permits with some of the proceeds being used to give short term subsidies to firms that need it in order to ease the transition to the new regime. Giving them away for free certainly doesn’t seem to promote efficient behaviour.