Something for Everyone: A Climate Policy That Both Environmentalists…

Something for Everyone:
A Climate Policy That Both
Environmentalists and Industry
Can Live With

By Raymond Kopp, Richard Morgenstern
and William Pizer

SUMMARY: Researchers at Resources for the Future propose an alternate
climate policy that has the potential to make both environmentalists and
industry happy -- it establishes binding emissions targets as long as costs
remain reasonable and allows the target to rise somewhat if costs are
unexpectedly high.

SEPTEMBER 29, 1997 -- Over the next few months big business
and environmental advocates will bombard the American public
with high dollar, slick advertisements reflecting the deep
disagreement that exists within the U.S. and across the world
regarding global warming and what actions, if any, need to be
taken.

The motivator for this media blitz is the upcoming December
meeting of the United Nation's Conference of the Parties in
Kyoto, Japan to consider climate change policy options.
Environmental advocates hope the U.S. will agree to binding
targets and timetables for reductions in the emissions of
greenhouse gases (GHG) which may be linked to disastrous
changes in the world's climate. Many in the business community
would like nothing better than to see no agreement at all. We
propose a policy approach that can make everyone at least
somewhat satisfied.

About the only thing the protagonists in this debate can agree
upon is that there exists great uncertainty about the two pieces of
information that are crucial to the development of a reasonable
climate policy: the gains from reducing GHG emissions and the
costs of attaining those reductions. While acknowledging our
own lack of precise information, environmental advocates believe
the risks to our planet posed by climate change are so great that
aggressive action must be taken now. By the same token they see
the cost of that action as relatively low. In contrast, many in the
business community see the climate risks as too uncertain and the
costs too high to warrant drastic action. They would prefer a
wait-and-see policy or, at most, a limited expenditure on GHG
emission reductions.

As a compromise, we propose an alternate policy. Recent
research* using a climate policy model developed at Resources
for the Future by William Pizer suggests that a hybrid system
coupling an emissions target with a relief mechanism for
unexpectedly high costs goes a long way towards addressing each
groups' concerns. In particular, the policy (1) fixes emissions
targets that are binding as long as costs remain reasonable and (2)
allows the target to rise somewhat if costs are unexpectedly high.



                                  Consider the position of those concerned about the environment.
                                  Their policy of choice is a tradable permit system where each
                                  permit gives the holder the right to emit a specified amount of
                                  GHG into the atmosphere. By limiting the number of permits,
                                  one can precisely control GHG emissions and guarantee they
                                  remain below the threshold for disastrous climate change. In
                                  contrast, while GHG emissions can be set with certainty using a
                                  permit system -- and by implication the benefits of GHG control
                                  obtained with certainty-- the cost of control is highly uncertain.
                                  That is, the cost to society, in terms of higher prices for fuel and
                                  reduced productivity, varies greatly under a permit system.

                                  Within the business community, as well as among consumers in
                                  general, the ideal climate policy is one that sets an upper limit on
                                  climate related expenditures. Businesses are interested in
                                  maintaining a stable environment for planning and investment.
                                  The risk of unexpectedly high compliance costs under a strict
                                  permit system thwarts that stability. For that reason, most
                                  businesses would prefer some sort of contingent policy that
                                  would keep costs low and predictable.

                                  The hybrid system we propose would establish a fixed number of
                                  tradable permits based on an emission target. It would then
                                  provide additional permits at a pre-specified trigger price. As
                                  long as the cost of controlling a ton of GHG emissions remains
                                  below the trigger level, the emission target would be attained.

                                  For environmental advocates, the hybrid approach guarantees that
                                  emissions will not exceed the tradable permit limit as long as the
                                  price of the tradable permits (i.e., the marginal cost of GHG
                                  control) does not rise above the trigger price. Based on their
                                  belief that the cost of reducing GHG emissions is low ­ and
                                  assuming these beliefs turn out to be correct -- the permit price
                                  will never reach the trigger level and emissions will remain
                                  capped.



For businesses, the policy guarantees that the cost of control per
unit of GHG emitted can never exceed the specified trigger price
that would be charged for additional permits (and could always
be less). Thus, while business leaders may still feel the benefits
of GHG control are not commensurate with costs, they can at
least make business plans based on the knowledge of a well-
specified cost structure.

The hybrid approach proposed here is not entirely new.
Aficionados of U.S. air pollution policy will remember that the
1990 Amendments to the Clean Air Act, which established the
sulfur permit trading system, also had a provision that enabled
industry to buy additional permits at a pre-specified fee. This
option was never exercised because the price of the permits (the
cost of sulfur control) began low and has fallen over time. Similar
mechanisms have been employed to regulate imports and
domestic agricultural production. More recently, economists
McKibbin and Wilcoxen went on record as favoring a hybrid
policy for GHG controls based on their concern about
enforcement, monitoring and international trade ­ important
issues, but distinct from our focus on benefit and cost
uncertainties.

A final advantage of the hybrid policy is its enhanced credibility
relative to a straight permit alternative. The idea that binding
targets and timetables will remain inflexible in the face of
unexpectedly high costs is unrealistic. By providing an automatic
mechanism to relieve cost pressure, the hybrid policy stands a
much greater chance of remaining in force and consequently
convincing businesses to take action immediately (instead of
waiting to see if the policy is eventually abandoned).



                                  The current choice of policies facing both environmental
                                  advocates and the business community are too tightly drawn.
                                  What we propose is a more flexible policy with the potential to
                                  address the substantive concerns of both groups, i.e.,
                                  uncertainties about both benefits and costs. The hybrid policy
does just that. By implementing a tradable permit system where
the pool of available permits remains fixed as long as the price
remains below a reasonable threshold, the risk of catastrophic
climate damages is greatly diminished. By capping the potential
expenditure on GHG abatement and allowing additional permits
to be purchased if costs turn out to be particularly high, the policy
protects against runaway costs for business and consumers,
enabling sound business planning.

This may not be fully satisfactory from the perspective of an
environmental advocate, but if the cost of GHG control is as low
as suggested by both the environmental community and our
experience with the sulfur trading program, these concerns are
unwarranted. Similarly, the business community may be unhappy
with the level of required expenditures -- but at least those
expenditures remain capped. While a hybrid policy does not
address all the thorny issues of GHG control, we believe it
provides a valuable degree of freedom to bring the sides together
and it may, indeed, be a valuable approach for the Clinton
Administration in Kyoto.

Raymond Kopp is a senior fellow at Resources for the Future (RFF) and
director of its Quality of the Environment Division. Richard Morgenstern is a
visiting scholar and William Pizer is a fellow in the same RFF division.




* The recent research by William Pizer mentioned in this article is detailed in
the RFF discussion paper, "Prices vs. Quantities Revisited: The Case of
Climate Change." It is the second of two papers by Pizer that deals with
uncertainty in climate policy. Click here to download this paper in PDF
format (which can be read with Adobe Acrobat Reader; if your computer is
not equipped with Acrobat Reader, click here to download the software
FREE). Click here for a summary of Pizer's first paper, "Optimal Choice of
Policy Instrument and Stringency Under Uncertainty: The Case of Climate
Change."

Click here to read The New York Times article by Peter Passell that mentions
this Weathervane article and discusses related policy options for combatting
climate change.