The future of carbon pricing

When the environmental movement was first getting underway in the United States during the 1960s and ’70s, command-and-control regulations were the weapon of choice for reducing pollution. Lawmakers and regulators would craft rules telling power plants and factories exactly how much pollution to cut — and, in some cases, what specific technologies to use.

(Pawel Kopczynski - Reuters) But an alternate approach rose up in the ensuing decades. Republicans and Democrats alike started favoring market-based policies that would set broad overall limits on pollution and allow industries to figure out for themselves how to meet those goals. So far, it’s worked pretty well. The cap-and-trade program for acid-rain pollution managed to cut sulfur-dioxide emissions at half the cost that conventional regulations would have. Same goes for the EPA’s program in the 1980s to strip lead out of gasoline. It’s no surprise that academics love these market approaches — they’re elegant and economically efficient.

But as Harvard’s Robert Stavins and Joseph Aldy write in a new paper in the Journal of Environment and Development, it’s unclear if the market approach to pollution is here to stay or just a historical aberration. Take climate change. Most economists would argue that a price on carbon should be at the center of any strategy to avert drastic global warming. Slap a tax on coal, oil and gas and watch the price signal ripple through the broader economy. Consumers will become more energy-conscious. Companies will adjust. Cleaner energy will sources become more cost-competitive. Capitalism will work its agile magic. What’s not to love? As it turns out, plenty.

First, some optimism. As a method of tackling climate change, carbon pricing has become far more widespread than is commonly assumed. The European Union has its Emissions Trading Scheme and is on pace to meet its targets. New Zealand has a cap-and-trade system. Countries like Denmark and Finland have relied on carbon taxes for quite some time, while Australia and British Columbia have recently followed suit. California just set up a cap-and-trade system for greenhouse gases.

But the trendline here is awfully fragile. Some of these policies, like Australia’s, face fierce opposition. And even if they’re more expensive in the long run, conventional regulations are often more politically palatable, because their costs are indirect and hidden. Here in the United States, we’ve long relied on fuel-economy standards over gas taxes to curb oil use — even though, as the CBO and other economists have insisted, flat fuel-economy standards are less efficient in theory.

And as far as global warming is concerned, the conventional wisdom is that cap-and-trade is dead here in the United States. Too politically risky. On the other hand, EPA regulation of greenhouse gases remains popular in the polls, even if it’s a clumsier approach. Likewise, California’s climate law uses a flurry of different regulations, such as the low-carbon fuel standard, to cut emissions — it doesn’t rely solely on carbon pricing. And many state governments have been pushing forward with laws to get a portion of their electricity from renewable sources, even though no one wants to touch carbon taxes. It’s quite possible that people simply prefer policies with hidden costs, no matter what the economists say.

As Stavins and Aldy note, ideas like carbon pricing might end up being a historical blip, and the world could eventually shift back to favoring conventional command-and-control regulations. (This is all assuming, of course, that policymakers actually do keep trying to tackle climate change — which in itself is hardly certain.) Economists won’t like it, but they don’t always get a say.