Wednesday, July 28, 2010

Supply and Demand

I have mentioned this before, but it's worth repeating. Cap-N-Trade is not some sort of magical market bullet that will solve global warming by determining a price for carbon. The best case scenario for Cap-N-Trade is that all permits are effectively auctioned off, in which case you get the exact same results as a correctly chosen carbon tax.

Take a look at your standard supply and demand graph:



Notice the two axes. One says price, the other quantity.

Under cap and trade, a quantity is chosen and corresponding number of permits is allocated.  The price change is then determined by the market.  But it's not some market price determined by, for lack of a better word, natural supply and demand.  No.  It's the market price determined by a government imposed scarcity.

Let me put it another way.  The amount of carbon that will be emitted is determined, ultimately, by political processes.  The market will then, after the quantity has already been decided, determine how much this is all going to cost in increased prices.

A carbon tax goes the other way.  We decide, again through political processes, how much we are willing to raise prices to fight global warming.  The reduction in carbon is then determined by the market.

So, carbon tax determines the prices first, then lowers carbon.  Cap and trade commits us to some carbon reduction, but we only know the price increase afterward.   Personally, I'd prefer to know the cost rise first.

Additionally, cap and trade brings complications when it comes to how the permits will be allocated.  If they are auctioned, like I mentioned above, then the revenue goes to the government and you have the same result as a carbon tax.  If, however, you give away the permits to favored industries, then you get something different.  Something worse. 

I'm not arguing that we don't need to fight global warming, although I do have some doubts about whether forgoing economic growth is worth it.    But in any case if we are going to do something, then let's not delude ourselves that the price resulting from an artificial, politically-imposed scarcity is somehow the miracle of the market at work.  In reality, it is a way to hide the costs of carbon reductions or provide political favors.  Best just to be upfront about the increase in prices, impose a tax, and adjust it accordingly to get the carbon reductions.

1 comment:

Anonymous said...

If one wants to be taken seriously on *fighting* global warming - btw, which one are we fighting? -- generic global warming or man-made which if I were a man I would object at the notion only men make global warming as women use far more electrical appliances then men plus they drive more of the SUVs. However a good place to start your fight no matter which global warming is your opponent, is adopting the practice of flying the family dog on the same plane as the family flies on. Crazy I know but we all must sacrifice in this fight, even our pets.

Just because the taxpayers have to pay for it isn't a good global warming argument is it? And just because the taxpayers have to pay for it again, instead of booking 30 suites/rooms at a 5 star hotel for a 4 day weekend with friends in Spain on your husband's b-day no less and your husband in this case is the Prez and he's the reason the taxpayers are paying for your jaunt, try doubling those friends up and only booking 15 as well as considering saying no to changing the beds daily by the hotel staff...

Like all wars, the fighting begins at home...

Mrs. P

 
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