Climate Change: Minefields Ahead

1 October 2007.

Climate Change: Minefields Ahead

At first sight, the government’s response to the challenges of global warming looks responsible and moderate.

And indeed it has some positive features.

The policy is not narrowly focused on electricity generation, as both the government and National were previously advocating, but covers all sectors of the economy and all greenhouse gases.

The government has recognised that a market-based mechanism – an emissions tax or an emissions trading scheme (ETS) – is the least-cost way of reducing emissions, and has opted for the latter.

It has been frank in acknowledging that the costs of the scheme will not fall ultimately on businesses but on households through increases in petrol, electricity and other prices.

And it has wisely abandoned the plan first introduced by National of confiscating the property rights of forest owners in carbon storage (although only for post-1989 forests).

However, leaving aside the scientific uncertainties about global warming and whether adapting to any warming trend would be preferable to combating it, there are still major dilemmas with the proposed course of action.

One is the wisdom of framing policy within the Kyoto framework of placing limits on total global emissions rather than reducing energy intensity – the amount of energy used per unit of GDP. The former strategy, primarily favoured by the European Union, involves unknowable economic costs, whereas the latter, which is more conducive to ongoing economic growth, is preferred by New Zealand’s trading partners in the Asia-Pacific region.

A second issue is whether the package is consistent with the government’s aim of achieving faster economic growth. The estimate that it would knock only 0.1 percent off GDP over 5 years is unsubstantiated. Moreover, it is based on low projected growth rates, not the government’s goal of 4 percent plus annual growth which is necessary if New Zealand living standards are to catch up with those of richer countries.

Thirdly, there is a fundamental lack of logic in seeking to scale back internationally efficient industries such as agriculture, aluminium and steel when the production shortfall may be taken up by industries in other countries that generate greater emissions. From a global viewpoint, it would be preferable on both economic and environmental grounds if, say, dairying expanded in New Zealand and contracted in the European Union.

Fourthly, the reasons given for favouring emissions trading over an emissions tax are unconvincing. A large body of economic opinion favours taxes on the grounds that they are transparent, provide greater certainty for business, and generate revenue that can be used to reduce other taxes.

An emissions trading scheme is a tax by another name, but it is less transparent and comes with the risk of major price volatility and political favouritism. The adoption of such schemes elsewhere owes much to the aversion of politicians to imposing taxes and to lobbying by vested interests that would benefit from trading (Enron was an early case in point).

Moreover, the proposed scheme is predicated on the development of a broad international market for emissions trading. But, as Greg Mankiw, a former chairman of the US Council of Economic Advisers, recently wrote, “Agreement on a truly global cap-and-trade system, however, is hard to imagine … American voters are not going to embrace a system of higher energy prices, coupled with a large transfer of national income to [countries like China and Russia].” The same may be true of New Zealand voters when they realise the consequences of emissions trading.

Beyond these large questions, a myriad of practical difficulties will arise over the details of a scheme.

The proposed entry of sectors on a staged basis is problematical, both because it would limit the scope for initial trading and because it is based on political judgments about their potential for adjustment, whereas the whole point of a market mechanism is to leave that judgment to market participants.

The plan also involves further takings of property rights without compensation (for example, by penalising farmers who change land use). It fails to recognise the property rights of pre-1990 foresters and the past efforts of businesses to reduce emissions.

Lastly, the task of allocating emissions units and verifying outcomes promises to be mind-numbingly complex, and the timetable for the scheme is rushed compared with the Australian government’s intention to bring in such a scheme in 2012.

Much water is still to flow under the bridge on climate change. Voluntary measures to reduce emissions are being taken by many firms and households and no other country has adopted the kind of comprehensive mandatory approach proposed by the government. Greater certainty in this area is desirable, but past mis-steps should be a lesson to both business and government that no policy will be stable unless it is built on sound foundations.

ENDS

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