Column: Dont create licence raj in climate

Written by Michael Walton | Michael Walton | Updated: Dec 10 2009, 02:39am hrs
Its getting cold in Copenhagen. A few degrees hotter could improve things for the Danes. That isnt true for future generations of Biharis, Bangladeshis or Zambiansor for anyone living in areas at risk of the (potentially) catastrophic effects of climate change. Thats a major reason why agreement on a climate deal is so hard: it is inextricably about distribution. It is also hard because it is a huge collective action problem. But it is the interaction between the collective action challenge and the absence of agreed upon mechanisms over the distribution of losses and gains that makes a deal really, really hard.

There are three distributional issues at stake: across generations; between rich and poor countries; and between different groups within countries. The first two just got more difficult because of the financial crisis. Its hard to worry about 2050 when youre at risk of losing your job. And the huge rise in public debt means rich nations face fiscal consolidation for years, increasing resistance to large transfers for mitigation and adaptation in poor nations.

Despite these difficulties, there is rising hope that a political deal will emerge from Copenhagen. It will be imperfect, but could be the basis for a treaty and better future arrangements. However, I want to focus here on the risk that within-country distributional issues will be a distorting factor, not because of helping the poor, but because concentrated interests will protect their position and engage in rent-seeking.

Take the major policy instrument of cap & trade. This looks like a brilliant solution to economic, distributional and political problems. Heres an ideal scenario. Rich countries get permits to emit greenhouse gases. Governments auction them to polluting industries, and use the revenues to finance innovation and adaptation in poor countries. Industries trade permits with each other, setting the price of carbon emissions in the market, thus fostering more efficient choices over emission reductions. Crucially, there are offsets for action in developing countries, as under the Clean Development Mechanism: industries can reach their limit through purchasing emission reductions from green projects in Brazil, China, India or elsewhere. This is good for efficiency and distribution: it reduces global emissions at a lower cost, and it transfers resources to poor countries. It also looks good politically since it avoids an explicit tax and finances mitigation in poor countries without government money.

The problem is that it isnt working like this.

First, in the European scheme many industries were excluded, and those included realised that they would do better to get large allocations of permits for free! They succeeded. American businesses have also managed to change the Obama planstill in Congressfrom an auction to free permits. Somehow this isnt a big issue in the public debate; whether permits are free or auctioned sounds arcane. Yet, who pays to reduce catastrophic risks for future generations is a big issue, justifying well-informed democratic debate.

Second, while some offsets will be a good sell politically (supporting forests, if that could be worked out), others wont. Providing transfers to help Chinese or Indian industries and power stations go green will be seen as subsidising the competitionpolitically lethal when workers lose jobs, and subject to business lobbying. This is already a theme in American discourse.

Third, there are real problems about how to verify that a project is additional. In the recent affair over Chinese wind farms, the Chinese government was accused of withdrawing subsidies in order to get offset funds from the Clean Development Mechanism. This looks like a system ripe for rent-seeking and obfuscation.

These issues become more important when the market for offsets becomes largeand that is badly needed if it is to have a serious impact and to avoid the problems of price instability that typified the European market. This all matters: if the system is seriously distorted, the costs of mitigation could rise much more than the 1-2% of GDP now estimated, and political support will be threatened.

Is there an alternative Much better would be an explicit carbon tax and transparent subsidies from rich to poor countries, with transitional compensatory mechanisms for losers in rich and poor countries. That really sounds like the musings of a nave economist! But I think these issues have to be openly discussed. Perhaps the tough choices over fiscal consolidation will focus the mind of rich country politicians: after all, a carbon tax (or indeed auctioning of permits) is a wonderful tax that reduces rather than increases distortions. In the meantime, since cap & trade is the main game in town, it will be important to have serious, open debate on the influence of sectional interests, who is paying and how to make schemes work transparently. Otherwise the devil in any deal will lie in the distributional details.

The author is at the Harvard Kennedy School, the Institute of Social & Economic Change and the Centre for Policy Research