Pricing Carbon Emissions

Economic Reality and Utopia

Aviel Verbruggen

• Publisher: Routledge
• Year: 2021
• ISBN:
  9781000415483
• Edition: 1
• Topic: Economia
• Subtopic: Economia ambientale

Pricing Carbon Emissions provides an economic critique on the utopian idea of a uniform carbon price for addressing rising carbon emissions, exposing the flaws in the economic propositions with a key focus on the EU's Emissions Trading System (ETS).

After an Executive Summary of the contents, the chapters build up understanding of orthodox economics' role in protecting the neoliberal paradigm. A salient case, the ETS is successful in shielding the Business-as-Usual activities of the EU's industry, however this book argues that the system fails in creating innovation for decarbonizing production technologies. A subsequent political economy analysis by the author points to the discursive power of giant fossil fuel and electricity companies keeping up a façade of Cap-and-Trade utopia and hiding the reality of free permit donations and administrative price control, concealing financial bills mostly paid by household electricity customers. The twilights between reality and utopia in the EU's ETS are exposed, concluding an immediate end of the system is necessary for effective and just climate policy. The work argues that the proposition of shifting to a global uniform carbon tax is equally utopian. In practice, a uniform price applied on heterogeneous cases is not a source of benefits but one of ad-hoc adjustments, exceptions, and exemptions. Carbon pricing does not induce innovation, however assumed by the economic models used by IPCC for advising global climate policy. Thus, it is persuasively demonstrated by the author that these schemes are doomed to failure and room and resources need to be created for more effective and just climate politics. The book's conclusion is based on economic arguments, complementing the critique of political scientists.

This book is written for a broad audience interested in climate policy eager to understand why decarbonizing progress is slow as it is. It marks a significant addition to the literature on climate politics, carbon pricing and the political economy of the environment more broadly.

The Open Access version of this book, available at www.taylorfrancis.com, has been made available under a Creative Commons Attribution-Non Commercial-No Derivatives 4.0 license.

1 Introduction

The EU ETS has a troubled history, and the environmental benefits of this economic instrument are contentious. Climate economics is linked to other economic disciplines. Understanding the essentials of economics enhances the debate about its most central climate policy tool, carbon pricing. Self-interest is a strong force in ordering private and public affairs. Financial incentives piggyback on this force to influence decisions and activities of economic actors. The incentives correlate with potential and effective money flows between the private and public sector. In stylized economic theory, based on the adopted assumptions, prices conquer the pole position, although in the real world, price is only an indicator and subordinate to money that people want to own.

Price theory is not easily converted in good pricing practices. Pigou’s tax for internalizing externalities is explained in Annex A, but the practical aspects of financial incentives reveal intricacies and pitfalls. Carbon pricing opens the cost-benefit analysis box [Annex B], delivering the concept of the Social Cost of Carbon, with much dispute about its numerical value. The second-choice carbon price (CP) in neoclassical economic theory is a GUCP, which would realize overall least costs for reducing given quota of carbon emissions [Annex C]. To obtain fluent and short text in the chapters, Annexes A, B and C document economic concepts of general use in the climate debate, also clarified with basic mathematical formality and graphs.

The discipline of this book is climate economics, at the junction of environmental and energy economics. In the 1960/70s environmental economics emerged as an offspring of welfare economics, itself indebted to microeconomics. Hence, climate economics is rooted in microeconomics. Main-stream neoclassical economics and its derivatives welfare and environmental economics are the main content. However, this chapter and the related Annexes A, B and C are not a copy-paste of content from conventional economics publications. The neoclassical economics material is presented with supplementary comments for broadening the perspective, crossing its narrow scope, and revealing its stylized approach built on many assumptions. In addition, fuzzy language in advocating uniform carbon pricing is exposed.

The purposes of Chapter 1 are

1. to describe the scene of climate and energy policy including carbon pricing and emissions trading,
2. to provide an introduction to the EU Emissions Trading System as I see it,
3. to clarify economic concepts used in the debate about carbon pricing,
4. to refute the argument that the global spread of GHG molecules is an argument for global uniform pricing, and
5. to recommend full transparency on the money patches and flows related to particular carbon pricing applications and proposals.

1.1 The scene of climate and energy policy, carbon pricing and emissions trading

Why do I add another analysis to the thousands of publications about carbon pricing and emissions trading? The authors of the numerous publications are mostly economists favouring and defending emissions trading in general and the EU ETS in particular as the single largest carbon market and the flagship or cornerstone of the EU’s climate policy. The framing and scope adopted by a study determine which concerns about the EU ETS structure, functioning, performance, effects, etc., are considered. The framing and scopes of the studies are diverse, generating a range of positions regarding carbon markets. A classification may encompass following (non-exhaustive) categories:

• Hagiographic, treating the subject with undue reverence (e.g., Ackerman and Stewart 1988; Baranzini et al. 2017).
• Apologetic, constituting a formal defence or justification of the doctrine (e.g., Ellerman et al. 2010; Hahn and Stavins 2011).
• Indulgent, sympathetic and suggesting remedies for the shortcomings (Ellerman and Joskow 2008; Neuhoff 2008; Passey et al. 2012).
• Independent, cautionary in observing and reporting its emergence and setup (Baldwin 2008; Meckling 2011) or functioning (Parry and Pizer 2007; Marcu et al. 2017; 2019).
• Critical about its pretended and actual performance (Toke 2008; CAN 2018; Rabe 2018).
• Rejecting, dismiss as inadequate, unacceptable, or faulty (Spash 2010; Pearse and Böhm 2014; Bryant 2016).

I consulted publications of the entire spectrum because all positions shed different lights on various aspects of the EU ETS. Confirmations of my own critical analysis are found in the cautionary independent and critical literature. By following the ups and downs of the EU ETS since its conception started in 1998, my academic critique evolved into deep concern about two lost decades for developing and deploying adequate policies for decarbonizing human activities.

I do not “take for granted the positive value of carbon markets” (Stephan and Paterson 2012, p. 547), and now I reject the propositions of the EU ETS being a good policy instrument, its axiomatic assertion of self-evidently truth, its biased use of mathematical theorems and its cheap slogan ‘a good idea sells itself’.

Academics with extended critique on carbon markets, and often rejecting the EU ETS, are mostly non-economists, for example Coelho (2015) qualifies carbon trading as ineffective, undemocratic, unjust and unethical, Pearse and Böhm (2014) discuss “Ten reasons why carbon markets will not bring about radical emission reduction”.

Among economists, an overwhelming majority approves the EU ETS, at least in principle. The economics community specialized in climate policy and carbon pricing exhibits strong resistance against investigating and questioning of the established wisdom about the role of prices and markets. My analytical lens for studying the EU ETS is economics: I employ the toolkit of neoclassical economics and its offshoot disciplines, such as welfare, environmental, and energy economics. Technical engineering research on one side and practice in political economy cases on the other side, enlarge the scope of my research lens.

However, this study of carbon pricing respects the essential economic concepts (such as self-interest, demand and supply, market, marginal cost pricing, etc.) and uses the standard mathematical theorems (such as Lagrange optimization). The concept of carbon emissions trading is valid ‘in theory’ (Tietenberg 2006). However, every implementation is circumstantial and contingent on the subject and context of the intended ETS. For example, for the EU ETS matter the legal, political, economic, social, environmental conditions of the Union, and the role of the European Commission (EC) as political entrepreneur (Skjaerseth and Wettestad 2010).

A study of carbon pricing and carbon trading for addressing climate change is not confined to theoretical theorems in a frictionless vacuum bubble. Design, set-up, and operation of financial incentives are influenced by, and interacting with, other forces active in society (Stiglitz and Stern 2017).

The diverse ranges of societal actors, living on a green Earth encircled by a blue Atmosphere, are driven or uphold by many forces, summarized in five interacting clusters [Figure 1.1]. Actors pursuing their goals manage and endure Ideas, Interests, Institutions, Infrastructures and Indispensable energy-technology transformations (Green 2016; Carlson and Fri 2013; Smil 2017). Climate and energy form an intimate diptych; a scholar neglecting one panel truncates the understanding of the other.

1. Ideas (myths, narratives, discourses, language, paradigms, etc.). Ideas influence the minds of people and purport legitimacy to the actions and positions of societal actors (Lakoff 2010). Biased language imprints faulty beliefs in the minds of people. At several occasions, substitution of appropriate language for flawed or imprecise expressions will be proposed and applied in this book. For example, it is better to say Donations of Permits (to emit volumes of GHG) instead of free allocation of allowances. Often, the essential word ‘free’ is omitted in publications. The neoliberal paradigm has been instrumental in pushing the policy and the public interest to roles subservient to markets and in setting up artificial markets, such as carbon markets. At several occasions, utopian constructions and utopian beliefs are crowding out the link with and the sense of reality. Trained as an engineer-mathematical economist, it took a long time before I started to understand the exceptional power of the cluster Ideas, i.e., discursive power, in the functioning of societies. Masterminding energy companies knew better.

While writing this text (April 3, 2020), my daily paper prints: “under the EU ETS electricity generators, industrial companies and aviation companies must buy emission licenses for every ton of CO₂ they emit”. This evident error seeds confusion in the heads of politicians and citizens and assigns legitimacy to a system that does not merit it.

2. Interests (positions, power, knowledge, capital, income, etc.). Interests are quantified and monetized in money stocks and flows, when the economic lens is applied. Carbon pricing and trading are evidently focused on money. Societal actors pursue their interests. Some actors (for example climate activists) may prefer non-monetary interests above money, but this is not the case for most actors listed in the centre of Figure 1.1.

Figure 1.1 The scene of climate and energy policy, carbon pricing and emissions trading

The cluster Interests is also connected to the Values adhered by people [Annex B]. Even Interests are very diverse, the economics logic reduces all Interests into the single yardstick of money. This reduction holds advantages when numerical precision substitutes for vagueness; the disadvantages are summarized in ‘all what owns real value has no price’.

3. Institutions (habits, norms, rules, property relation, laws, institutes, etc.). Institutions structure the polity of society (Vatn 2005; Bromley 2006). A political scientist would specify many institutions and institutes making modern societies, such as governmental, legal, administrative, communicative, social, economic, scientific, and more.

I highlight only the institution market as created and run by people. Generally, markets start spontaneously, either because a supply searches a demand, or a demand triggers a supply. In theory, markets serve mutual interests and guarantee free entry and exit, why they merit the predicament ‘free’. Once markets develop and grow, volitional (Bromley 2006) or public authority is needed to provide a regulatory framework to avoid fraud and implosion of the structure.

Carbon markets are top-down artificial constructs. Public authority supplies permits (or licenses) to emit as a commodification of nature and common goods. The demand is the result of coercion by a public authority. Supervision is evidently also the responsibility of public authority. This is a caricature of a sound market institute.

4. Infrastructures (buildings, transport, production, commerce, recreation, etc.). Infrastructures are visible artifacts. They materialize how societies thrive and function. Drastic and urgent change conflicts with lock-in and inertia inherent to large and long-living infrastructures. The energy systems are deeply embedded in all major infrastructures. Dealing with climate change means reducing the GHG emissions of the energy systems to zero, urgently because of the irreversibility of broken ecosystems.
5. Indispensable energy and technology transf...