Managing risk in emissions trading

Call me crazy but I get the sense that the Government is nervous about emissions trading. The issue is this: there is a clear desire for Australia to make up for past sins and play its role in the global effort to mitigate climate change. This mean jumping from a lagger to a leader. This means having a full plan on the table. Near as I can tell all serious commentators in this space from Garnaut to McKibbin agree with this bit.

The nervousness comes from the fact that for a large scale economic reform effort like this, we just do not know what the economic costs are. The one thing we do know is that they will be felt now whereas there will be no benefit other than that of — and this is going to be the more obscure popular culture reference in history — “you’re all doing very well” (Young Mr Grace in Are You Being Served?). The politicans know what that really means come election time and the Coalition has already moved back to the past to cover themselves for that eventuality.

Ross Garnaut takes a big stand on risk. He says, the risks come from not allowing the market to reach its full potential and opting for something that is complex, involves many exceptions and will lead to rent-seeking. So he wants a big bang but simple and straightforward approach. Establish property rights everywhere and be done with it.

On the other side is Warwick McKibbin. He has been arguing for as long as I can remember that the risks are all in a major economic cost blowout. We may find that the costs are just too high and if we expose the economy to it, the polity will go back to the past and the policy will unravel. He argues that we need to take out an insurance policy to contain the carbon price until we work out what is going on. What is more, he is one person who has modelled the risks and compared it with those of a Garnaut-style plan. That said, for an argument based on securing political support, it has not yet done that job anywhere in the world.

Both of these extremes could be right but it is hard to tell. I also worry about a cost blow-out as well as a blow-out in rent-seeking. For this reason, John Quiggin and I have argued that to minimise risks and allow for learning we should start sector-by-sector. Energy stands out for me (as it is a big emitter) and flows through the economy. What is more there are established markets whereby emissions trading could be easily integrated so the skill set required to deal with that is minimal. It is also a sector that has known this was coming.

The other sector is transport — especially petrol based. I think the world economy has already done its job there. What I would like to see is the government use a tax to ensure that the price of petrol consumers see does not fall from its current level. Basically the excise tax should being a floating one designed to prevent a return to lower petrol prices and send a signal to everyone that it is here to stay and so make your investments accordingly.

The best thing about hitting energy and transport is that the price signals will flow through to businesses and consumers and we can start to get the benefits of behavioural change and substitution. The other best thing about it is that the hits both major sources of pollution so dealing with emissions is a two-for in that we are just conducting sensible environmental policy per se. So if it turned out that dealing with climate change isn’t the biggest issue then we have still done well by the environment.

In other sectors, especially land use, I would use a non-market approach to assess costs and then see how we are travelling in 2012.

I see the full blown emissions trading regimes as too risky at this stage with too much of a reliance on unfamiliar markets. As an economist, I think markets can do a job. But, in this case, a gradual approach to that seems warranted coupled with aggressive complementary, non-market policies to ensure that we meet international obligations.

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