Carbon Trading: An Overview And Criticism

The issue of climate change is one of the most enthralling issues of our times which has implications in almost every sphere and area of life. It has geographical, climatic, social, economic and political implications and in terms of economic analysis at least, greenhouse gas emissions which cause planetary climate changes is a representative of both- an environmental externality and the over utilization of a common property resource.

Recently, on July 2017, there was a news that NITI Aayog may soon start a cap-and-trade emission scheme for industries, which will involve a market for industries to buy and sell permits to allow them to emit a certain amount of particulate matter (PM 2.5). Energy Policy Institute at the University of Chicago (EPIC) is working on a feasibility study for the same, and helping draft the policy for NITI Aayog. An Emission Trading System like Carbon Trading would work in the following way according to Jonathan Harris, author of The Economics of Global Climate Change-

• Each nation would be allocated a certain permissible level of carbon emissions. The total number of carbon permits issued would be equal to the desired national goal. For example, if carbon emissions for a particular country are currently 40 million tons and the policy goal is to reduce this by 10%, then permits would be issued to emit only 36 million tons.
• Permits are allocated to individual carbon-emitting sources in each nation. Including all carbon sources (e.g., all motor vehicles) in a trading scheme is clearly not practical. Instead, under most proposals, permits would be allocated to the largest carbon emitters, such as power companies and manufacturing plants, or else to the suppliers through which carbon fuels enter the country – oil importers, coal mines, etc. These permits could initially be allocated for free on the basis of past emissions or could be auctioned to the highest bidders. Economic theory indicates that the effectiveness of the trading system should be the same regardless of how the permits are allocated. However, there is a significant difference in the distribution of costs and benefits: giving permits out for free essentially amounts to a government subsidy to the polluters, while auctioning permits imposes real costs upon firms and generates public revenues.
• Firms are able to trade permits freely among themselves. Firms whose emissions exceed the number of permits they hold must purchase additional permits or else face penalties. Meanwhile, firms that are able to reduce their emissions below their allowance at low cost will seek to sell their permits for a profit.
• Firms will settle upon permit prices through free market negotiations. It may also be possible for environmental groups or other organizations to purchase permits and retire them – thus reducing overall emissions.
• Nations and firms could also receive credit for financing carbon reduction efforts in other countries. For example, a German firm could get credit for installing efficient electric generating equipment in China, replacing highly polluting coal plants.

However, there are many downfalls to the Carbon Trading System. It has become a source of windfall profits for polluters through its failed mechanisms, offshore carbon offsets, and it has in fact led to emissions not being reduced, but only regulated in a manner which ensures profits for the polluters with very little pay off to the environment.

With unfair allocation of allowances, complexity of the apparatus setup, difficulty in quantitative and qualitative measurement, lack of a just regulator (without conflicts of interest), and the potential for the entire carbon market to become a gambling arena for carbon price speculators and traders, the objective of carbon trading to actually reduce emissions is lost in its many flaws. With geographical and cultural differences, it is difficult to come up with a measure of climatically equivalent solutions on a global scale and even positive solutions to combat global warming are hindered by carbon trading as mentioned above. Thus carbon trading despite its theoretical advantages has many theoretical, practical, social, economic and general flaws which do not help it achieve its objective, even if it leads to a slight reduction in emissions. The difficulty in the allocation of allowances, regulation, and the potential social unrest which could be caused by carbon trading highlights its drawbacks.

According to Daniel Tanuro, author of Carbon Trading: An Ecosocialist Critique, climate change being a social and political question, requires real democracy, social justice and climate justice overall in order to help being dealt with. The approach he advocates instead of carbon trading to deal with the issue includes-

• “non-tradable quotas and sanctions;
• compulsory phasing out of some products, processes, technologies and transportation systems;
• public initiatives, rather than market incentives in energy efficient buildings, land management, transport, etc.;
• public initiatives to quickly develop renewable energy sources independently of their costs;
• redistribution of wealth and democratic planning with popular participation at every level from local to pan-European.

This alternative approach should be viewed in the broader context of a global climate mitigation strategy that fully respects the “common but differentiated responsibility” principle and the right of all people on Earth to emit carbon equally.”

However, the system of Carbon Trading can be improved. According to Carbon Trading: A Review of Kyoto Mechanisms, because climate change is the biggest market failure in the world, the Emission Trading Scheme created to address it can be looked at as the greatest ever privatization of a natural asset. The carbon markets thus show a highly flawed step in addressing it, and one of the biggest challenges in the climate policy for the next decade or so, (after all flaws in the current system have been rectified) is to increase the scope and extent of the emissions trading system to include more countries, more sectors and over larger periods of time, so as to bring about a general, equivalent, universal regulated market, with caps tightened (lower budget of allowances) to improve environmental efficiency and effectiveness, with auctioning of allowances to address the flaws of the carbon trading system with respect to inefficiencies in allocation and just distribution of allowances.

Climate policies like regulation, carbon taxes, and provision of information will continue to play an important role, but a lot of human, social, political and negotiating capital has been invested in the policies, and institutions of the flexible mechanisms of the Kyoto Protocol, in which Carbon Trading was the centrepiece. Even though these flexible mechanisms like Carbon Trading have serious flaws, they form an important basis to construct, develop, implement and execute a better, more sensible, effective and efficient global climate policy, and thus Carbon Trading despite its many flaws can be the backdrop reference and basis for constructing a new global climate policy without the flaws of the current system.

Anurit Kanti

BW Reporters The author is correspondent at BW Businessworld, he has a keen interest in sustainability and environmental economics