Economists fiddle while climate burns
According to a growing band of economists, we'd be better off using a carbon tax to reduce greenhouse gas emissions, not the emissions trading scheme the Rudd Government introduced to Parliament this week.
My opinion? Don't believe it. It may be a case of the grass being greener on the other side of the fence. Whichever way the Government had jumped there'd be a bunch of economists arguing that the other way would have been better.
What unconsciously worries them, I suspect, is the knowledge that we're dealing with a form of microeconomic reform that limits economic growth rather than promoting it.
Even though all the economic modelling tells us the growth forgone would be minor, their instincts tell them the economic disruption would be huge. That's certainly what the business community imagines (though, at this point in the lobbying process, business is no doubt exaggerating its true fears).
The "cap-and-trade" system embodied in the Government's carbon pollution reduction scheme involves a government setting a (slowly reducing) cap on the amount of carbon dioxide emissions it's prepared to allow each year, then issuing to carbon-emitting industries permits equal to the cap. Businesses that find they have more permits than they need are able to sell them to businesses that find they don't have enough.
By contrast, a carbon tax involves a government imposing a tax of $X per tonne of carbon on industries engaged in emitting carbon dioxide. By raising the price of emissions-intensive goods and services, the tax is intended to discourage the consumption of such goods and services, while also providing producers with an incentive to find ways of reducing the amount of emissions generated by their production process. The tax would have to be raised until it brought about the desired reduction in emissions.
The cap-and-trade system works in a similar fashion. By limiting the total emissions allowed, it raises the scarcity value - and thus the price - of emissions-intensive goods and services.
The emission permits also gain a scarcity value which, provided it sells the permits rather than giving them away, ends up in the government's coffers. The value of permits gives businesses an incentive to reduce their emissions so they need to buy fewer permits and are able to sell any they don't need.
You can see the two systems are different ways of achieving the same objective. Cap-and-trade works by controlling the quantity of emissions permitted and allowing the market to set the price, whereas a carbon tax works by controlling the price of emissions and allowing the market to determine the quantity of emissions.
In theory, cap-and-trade is slightly more sophisticated because it involves creating a new market for the trading of permits, which facilitates shifting the cost of reducing emissions to those businesses most able to bear it (that is, the ones that can reduce their emissions most cheaply).
In practice, however, some economists fear cap-and-trade is too sophisticated. It would be harder to administer than a tax, and the market price of permits could be unstable.
Some economists support a carbon tax because they believe it would be easier politically. The pollies don't face the temptation to give out free permits, they just have to raise a tax rate, which is quite simple.
But most economists don't have much feel for politics and I think it's a delusion to imagine one approach is clearly superior to the other from a political perspective.
The simple truth is that neither system can give the pollies political courage they don't possess. A government that doesn't have the courage to sell permits rather than giving them away to polluters is a government that wouldn't have the courage to keep raising a pollution tax until it brought about the desired reduction in emissions.
One major problem common to either system is that the demand for power and petrol is pretty price-inelastic. That is, the price of permits or the rate of the carbon tax would have to rise a long way before it did much to discourage demand.
One good reason for preferring a trading scheme is that it fits better with what other countries are doing and allows international trading in permits. Where other countries can reduce their emissions more cheaply than we can, we effectively pay them to do it for us.
The use of "economic instruments" such as an emissions trading scheme or a carbon tax is intended to minimise the economic cost - in terms of economic growth forgone - of achieving protection of the environment.
But if there's a rational reason for economists preferring one system over the other - that is, if it's not just the grass being greener - I think it's which objective they give higher priority: minimising the economic cost or maximising the environmental certainty.
If your greater concern is achieving the desired reduction in emissions then you go for the scheme that gives you control of the quantity of emissions; if your greater concern is minimising the loss of economic growth then you go for the scheme that gives you control of the price of emissions.
So if economists tend to favour a carbon tax it may be because they're a lot more concerned about giving up a bit of economic growth than they are about doing insufficient to prevent global warming. Implicitly, they're not convinced climate change constitutes as great a risk as the majority of scientists tell us it is.
The hidden logic seems to be that if we find reducing emissions more economically disruptive than we expected we can simply stop raising the rate of the carbon tax and not much harm done.
Of course, the weakness in this line of thinking is that if the scientists are right - and the signs so far are that they've understated rather than overstated the size of the problem and the speed at which we're approaching the point of no return - then the ultimate loss of economic growth will far outweigh the loss the economists imagined they were trying to avoid.
But whatever the economists' motives, you could understand if the politicians were unimpressed by their performance. Economists are always making speeches about the need for governments to have the courage to implement politically unpopular reforms that will ultimately leave us better off.
Right now we've got a Government trying to introduce a highly controversial reform, under fire from all directions. So where are the economists? With a few honourable exceptions they're away attending a seminar entitled, "Maybe another way would have been better?"
Ross Gittins is the Herald's economics editor.