Rather than wait for Penny Wong, we thought we’d jump the gun with our own Paper on the options for addressing climate change.

The key thing to bear in mind with all this stuff is what we are actually trying to achieve. Yes, yes, we’re trying to do something about the greenhouse effect, but what, specifically, and how? Answering that question properly leads into hotly-contested debates about economic and administrative efficiency, where tiny details can have vast and unforeseen real-world consequences.

So what are the criteria for an effective carbon abatement framework?

  • It creates genuine incentives for carbon abatement across the economy i.e. it works.
  • It avoids administrative complexity and compliance burdens. Businesses and governments have to be able to make it work, without devoting huge amounts of resources to it.
  • It is complementary to likely international carbon abatement measures. There’s lots of scepticism about the likelihood of an international agreement on climate change, but that’s even more reason to look for a framework that is more likely to be accepted internationally.
  • It minimises the burden on low-income households.
  • It encourages technological innovation, because technology may be able to make it easier and less expensive to reduce our carbon emission (we’ll discuss these two points more tomorrow when we look at the issue of compensation).

Let’s go through the different types of proposals and see how they stack up.

Do Nothing

This needs to be considered, and not just as a sop to the sceptics. If the cost of addressing climate change is greater than the costs it will inflict on us, then there’s a strong case for not doing anything. In the absence of an international agreement, it is also a scenario that might be forced on us regardless of what we choose to do in Australia.

Under this option, we accept the inevitability of global warming, maximise national income to increase our standard of living and, to be prudent, establish a Future Fund-style national insurance scheme to compensate communities affected by climate change as it becomes apparent.

Advantages: Well, duh, we don’t have to do anything. And it maximise the competitiveness of our exporters who will be unencumbered by carbon costs. Having yet another Future Fund will also further increase the national investment pool.

Disadvantages: The costs of climate change are unclear, and may be far more severe than currently modelled. Climate change will also directly affect Australia’s economic capacity through impacts on agricultural productivity, to an extent that may be greater than we can compensate for — how much compensation would you need if the Murray-Darling stopped flowing? Australia would also become an international pariah, and potentially face restrictions on our exports due to their “carbon-free” status.

“Howard-Bush model”

So named after two leaders who suggested — even if they didn’t really believe it — that all that was needed to fix climate change was some good old-fashioned know-how that would yield a silver bullet solution. Under this model, we would direct massive investment into new carbon abatement and efficiency technologies in the hope that a solution to the greenhouse effect will be found, or we can quickly shift to an economy with significantly lower emissions.

Advantages: No pain for anyone, and therefore none for politicians. Great for companies who could replace their R&D budgets with taxpayers’ money.

Disadvantages: Given the sad fact that we are living in the real world rather than in Doctor Who, a brilliant piece of scientific wizardry is unlikely to save us. In any event, no new technology can be developed and rolled out to replace existing systems sufficiently quickly to slow climate change. And most of all, in the absence of price signals or other incentives to adopt new technology, it will remain in the laboratory or on the warehouse shelf anyway.

Regulation

Let’s just ban carbon. Cross it out of the periodic table. Or, slightly more plausibly, legislate a cap on annual CO2 emissions from business that reduces each year, with civil and criminal penalties for companies that breach their annual cap.

Advantages: Creates a clear incentive to reduce carbon emissions.

Disadvantages: Well, where to start? It would create a massive compliance burden — businesses would have to be audited first, and then heavily vetted afterwards by specially-tasked regulators (the “carbon police”, perhaps Radiohead could provide the theme song). There would be no incentive for reducing emissions below each business’s limit, and regulatory costs would be passed straight through to consumers, with no means of offsetting them. It’s also unlikely to complement international measures. In short, who’s the idiot who raised this option? Oh, I did.

Carbon tax

Simple — impose a fixed carbon tax on all emitters, at a rate sufficient to create significant price signals discouraging carbon use.

Advantages: Administratively simple. Provides certainty for business about the cost of emissions, and encourages minimisation of them. It also generates a substantial pool of revenue that could be used to compensate households or businesses, or invested in new technology research. The tax could be adjusted upwards to accelerate carbon abatement. Given its simplicity, it’s likely to be complementary to international abatement efforts.

Disadvantages: A tax creates an inflexible structure that relies on disincentives only. In particular, it wouldn’t distinguish between business that can easily reduce carbon, and carbon-intensive industries, or those with long-term investments. A taxation rate also creates incentives for politically-inspired meddling with the level — can’t you just see a politician going to an election on the basis that “times are tough — we’ll ease the carbon squeeze with a 10% carbon tax reduction”?

Cap and trade scheme

Garnaut’s preferred model. Set a cap on national carbon emissions and auction tradeable permits up to that level.

Advantages: Unlike a tax, cap-and-trade has the market, rather than politicians or bureaucrats, determine the appropriate cost of reducing emissions, minimising the risk of inefficiency through over or under-pricing carbon. The opportunity to trade permits creates both disincentives and incentives for carbon abatement, with unused permits available for selling to firms that need them. This encourages efficiency by “directing” carbon emissions to those sectors that value them most or which are unable to rapidly switch to lower emissions. It also provides a potential basis for international trading of permits, which would avoid trade disputes over carbon taxation of exports. The scheme has flexibility to allow free allocation of permits if desired, and provides a pool of revenue to compensate households or businesses, or invest in new technologies, while also allowing business to earn revenue from lowering emissions.

Disadvantages: Administratively highly complex, and untried on a wide scale in Australia. Likely to be welcomed by lawyers as guaranteeing steady income for generations to come. Most significantly, it creates uncertainty for businesses as the price of permits is uncertain and variable. Given its complexity, the scheme is unlikely to match in detail even other cap-and-trade schemes adopted internationally.

Hybrid scheme

Similar to “cap and trade” but with floor and ceiling prices for permits.

Advantages: In addition to benefits of cap-and-trade, greater certainty for businesses in relation to the carbon price, which will only move between the floor and ceiling levels.

Disadvantages: does not actually guarantee reductions in emissions, as businesses will be able to continue buying permits at the ceiling price to cover emissions. Less likely to complement an international scheme. And like hybrid models in lots of areas, it’s OK at doing a couple of things but not great at doing either.

McKibbin model

Being pushed by Reserve Bank board member and prominent economist Warwick McKibbin, as well as those at the more sceptical or gradualist end of climate change debate. Complex, but essentially aims at a long term emission goal, with a uniform reduction each year leading to that goal but capacity for long-term hedging of risk. Operates through an allocation to all households and businesses of a long term emissions bond with annual permits based on each year’s target. A carbon bank sets the price of permits for each year over a five year period and sells long-term and short-term permits.

Advantages: Avoids an arbitrary decision about each year’s carbon ceiling (there is no current scientific basis for deciding exactly how much carbon we should be emitting in 2010, other than that it should be less than what we currently emit). Critically, it provides certainty for business via a fixed prices for permits. Revenue from the scheme goes to businesses and households, not governments, removing politicians and bureaucrats from the equation. It avoids (or in fact ignores) the problem of a lack of international agreement or a breakdown of agreements. And importantly, it allows long-term hedging of risk, especially for large-scale emitters.

Disadvantages: Economically pure but even more complex than cap-and-trade, especially for households, which would all receive a long-term carbon permit. Short of Warwick McKibbin becoming king of the world, it will not complement any international trading framework. It would also encourage individual businesses to delay carbon abatement measures into the future, when there is a strong argument that we need to get cracking on emissions. And most of all, it does not cap annual emissions.

Conclusion

A “cap and trade” emissions trading scheme is the least worst option in terms of carbon abatement and the one with the greatest flexibility. But it is clear that the uncertainty engendered by the auctioning of permits will be a significant issue for businesses once a serious carbon cap is in place. This is not a small issue, particularly for carbon-intensive industries that have to consider long-term investment decisions. The model now being advanced by Warwick McKibbin has advantages in this regard, providing for price certainty each year.

McKibbin’s model also has the appeal of eliminating political decisions about how to spend revenue from a carbon tax or cap-and-trade scheme, especially given the Garnaut recommendation that some revenue be used to fund new technologies — a decision likely to see considerable lobbying from industry and trade unions about where it should be directed. The issue might be one of the biggest facing the planet, but that doesn’t mean rentseekers and opportunist politicians won’t be looking for any possible opportunity to exploit a carbon abatement scheme.

Tomorrow in the Crikey email: how to spend all that carbon cash…

Tomorrow at Crikey online: commentary and details as soon as Penny Wong delivers her green paper address. Read it first at crikey.com.au.

Get Crikey for $1 a week.

Lockdowns are over and BBQs are back! At last, we get to talk to people in real life. But conversation topics outside COVID are so thin on the ground.

Join Crikey and we’ll give you something to talk about. Get your first 12 weeks for $12 to get stories, analysis and BBQ stoppers you won’t see anywhere else.

Peter Fray
Peter Fray
Editor-in-chief of Crikey
12 weeks for just $12.