Economic Thought and U.S. Climate Change Policy

6 - Neoliberal Instrument Choice

Economic theory has profoundly influenced policymakers’ thinking about the selection of instruments to effectuate environmental policy goals. And this thinking about the economics of instrument choice has powerfully influenced the United States, leading its government to strongly support environmental benefit trading as an instrument of climate change policy. This chapter will discuss this influence. It begins with a basic explanation of emissions trading, a form of environmental benefits trading , and a short summary of its history. It then recounts the United States’ embrace of unrestrained international environmental benefit trading as a climate change remedy and how this has influenced U.S. and international climate change policy. It closes with some analysis of the advantages and disadvantages of the United States’ posture in this regard. Economists have long lamented traditional regulation’s inefficiency, referring to it pejoratively as “command and control” regulation (an epithet embraced by many noneconomists as well).1 They have recommended either pollution taxes or emissions trading in order to remedy this inefficiency , with most of them tending to prefer taxes.2 President Clinton at one point proposed employing an energy tax to address climate change, which would create an incentive to reduce emissions of carbon dioxide, the principal greenhouse gas. But the rejection of government that Chris Schroeder has described carried with it an extreme aversion to new taxes, and Congress would not support such a tax. Hence, antigovernmental attitudes played a role in limiting even the choices among instruments that economic thought commends.3 In the climate change arena, economists’ second-choice environmental instrument, emissions trading, gained much more traction. It fit in reasonably well with the prevailing free market ethos and seemed to some policymakers to offer an alternative to government regulation. Accordingly, a brief explanation of emissions trading and its history will prove useful. 6 Neoliberal Instrument Choice David M. Driesen 130 D. M. Driesen I. Emissions Trading Described U.S. law often relies on uniform performance standards as a means of meeting environmental goals.4 Such standards require all firms within an industry to reduce emissions by an amount that the government chooses. This leaves firms with some technological flexibility, as polluters may choose any technology that meets the regulatory limit.5 But it requires each regulated unit within a facility to meet the government-specified target . It is spatially specific regulation.6 Economists consider uniform performance standards inefficient. A uniform standard does not produce uniform costs among regulated facilities . Indeed, facilities within an industry commonly encounter widely varying compliance costs when meeting a uniform target. This implies that an industry could meet the same aggregate reduction demanded through a uniform standard more cheaply if facilities facing high marginal control costs made fewer reductions than the uniform standard demands and those facing lower marginal control cost made more reductions than the uniform standard demands. Unfortunately, government officials rarely have sufficient marginal control cost information to finetune regulation to match each facility’s cost structure. Indeed, governments employ uniform standards precisely because they allow officials to regulate large groups of facilities without having to tailor regulation to each firm’s circumstances. An emissions trading approach allows the owners of regulated facilities themselves to shift around their pollution control obligations to achieve the least-cost allocation of emission reductions.An emissions trading scheme begins with a government regulator setting a uniform standard, just as with traditional uniform performance standards. But when the regulator uses trading, she authorizes owners of pollution sources to forgo a required reduction if they pay other polluters to make extra reductions in their stead. Given the opportunity to trade around compliance obligations in this manner, polluters with high local marginal control cost will presumably forgo local reductions and pay somebody else for extra reductions instead. Conversely, facilities with low marginal control costs will make enough extra reductions to sell them to facilities that would otherwise face high marginal control costs. The polluters themselves rearrange their reduction obligations to achieve the goal the regulator has set for the industry as a whole at lower cost than would happen if each regulated entity met a uniform target. This approach rather ingeniously allows for Neoliberal Instrument Choice 131 efficient fine-tuning of regulation without the government having to tailor regulation to each facility’s special cost situation. Trading proponents often claim that emissions trading stimulates innovation more effectively than traditional regulation.7 Innovation consists of the development and use of a new...