When someone throws some new economic modeling to the media, it always disrupts my day. Can’t let it go until I understand what is going on. Digesting — even in a preliminary way — the new Frontier Economics report on the CPRS released by Malcolm Turnbull today, has taken me a little time. The headline was compelling: we can have a CPRS with a fraction of the economic cost and with a doubling of the emissions target. Wow, now that is what I call a free lunch. How did they do it?
Let’s first list some things that were not contributing. First, shielding export-intensive industries and agriculture fully means that the emissions reductions have to be found elsewhere although allowing agriculture to contribute offsets has go to help with the economic costs.
Second, the new proposed arrangement for electricity generators is to not require them to purchase permits and be compensated for the asset-value hit. Instead, like export industries, they will receive a permit allocation based on output multiplied by an emissions intensity. So if you are a big coal fired polluter, for each MW you produce you have to go to the market to buy some permits (not all of them but for your emissions ‘inefficiency). And if you are a lean hydro producer, you have permits to spare and so for every MW you produce you are being subsidised. The difference between the polluter and non-polluter is the same as under the CPRS (see Frontier’s Garnaut submission pages 10-13 for an explanation) and that means, holding output fixed, the mix of emissions from electricity is the same as under the CPRS as is the hit on the profits of polluters. But the important bit is that electricity output — at least with inelastic short-run demand — does not contract and so employment doesn’t fall by as much and consumers are shielded from much of a price increase. In the short-run, there is said to be a big economic saving as consumers and others couldn’t do much with the higher CPRS energy price signals anyway. Of course, had the government been compensating the households more for this rather than businesses then the economic hit and flow on effects could be minimised. In each case, we are relying on the long-run commitment of higher energy prices and factoring that in to durable decisions to make up the behavioural response. The point is, that the free lunch isn’t really here or at least wouldn’t be if the government was doing its compensation right.
On the compensation score, there is plenty of concerns that the Government’s plan will stick and compensation might never go away. But that is a risk on this alternative too as the baseline electricity permit allocation will be decided each year. There is the same risk of political hold-up, etc.
So where is the gain? It is all in the, post-international agreement, ability to purchase permits internationally. Let’s be very clear: that is the policy here. Economists all know that so long as the international agreement is a real one with country-specific permits that can be audited properly, then allowing more trade in permits globally will achieve the same emissions reduction for much less cost. It is the reason why we have a cap and trade scheme rather than a harder to standardise carbon tax. I, for one, am not against this being allowed and, indeed, if the proposition from the Opposition is that we go for a 10 percent unconditional target in return for a greater international permit trading position following an international agreement, that is something we can get behind. All the other stuff, looks like bells and whistles — at least at a first glance.
[Quick Update: Another aspect of this is that it is really about delaying the ETS in its economic impact with a quicker ramping up later on — especially with an international agreement. In that respect, it is in line with previous Coalition statements on a wait-and-see approach. But I wonder if it would be just more transparent to argue that they want the ETS put in two years later than the government but are happy to legislate that commitment.]