Green garble

Would pollution permits cripple Kazakhstan’s economy?

Kazakhstan plans to control carbon emissions, which create global warning, by issuing pollution permits that can be bought and sold.  To reduce emissions, the government can just issue fewer permits.  Carbon polluters – such as power plants that burn coal in order to generate electricity – protest that the permits cost too much.  That, to put it charitably, is a misunderstanding.

Under reasonable conditions, marketable pollution permits minimize the cost of controlling emissions.  I don’t mean the price paid by the power plant for the permit; its emissions do real damage, so it should pay for the privilege.  I mean the cost to society of pollution control.  For example, some plants may reduce carbon emissions by switching to natural gas or nuclear power.  The cost of this transition may force a plant to layoff workers.  This loss of jobs entails a true cost to society.  We may want to cut carbon emissions, by the given amount, with the smallest possible loss of jobs (or, more generally, with the smallest possible loss of human welfare).  Marketable pollution permits can do this.

To see why, let’s look at how governments usually reduce pollution – “Command and Control”, which orders all polluters to cut emissions by a given percentage (say, 50%).  Consider two power plants that each emit 2 million tons of carbon.  Plant A has equipment designed solely to burn coal.  To halve emissions, it must buy equipment suitable for natural gas.  Reducing carbon emissions by a million tons will cost it $3 million.  Plant B already has equipment for burning either coal or gas, and it can switch to the latter fuel easily.  It can halve emissions for only $1 million.  Under Command and Control, each plant would have to reduce emissions by 1 million tons, at a total cost of $4 million ($3 million for plant A, $1 million for plant B).  It would be cheaper to have plant B cut back by the full 2 million tons, since this would cost only $2 million.  Marketable permits can make this happen.

How?  Suppose that each permit would let its holder emit one carbon ton.  Plant A would want to pay as much as $3 for the permit, since otherwise it would have to pay $3 to avoid emitting the ton.  Plant B would be willing to sell a permit for as little as $1, since it can abate the ton by spending a dollar.  Thus each plant would gain $1 by trading the permit for $2 (B would sell to A).

The gains to polluters are not the issue.  The point is that the exchange enables society to abate the carbon ton as cheaply as possible – for $1, or, more precisely, for a dollar’s worth of physical capital and labor.  Under command and control, the abatement would have cost two dollars’ worth of resources.  The marketable permit frees up a dollar’s worth of resources for producing other things of value, such as research into global warming.

Inflating the facts

A permit system isn’t essential.  The government can achieve the same cost-minimizing outcome by taxing each polluter $2 for emitting a carbon ton.  Plant A will pay the tax and Plant B will abate instead.  But under the tax system, firms can pollute as much as they wish, as long as they pay up.  True, the government can cut pollution by raising the tax rate, but finding the best tax may take several years; meanwhile, the environment may suffer.  Since we are not sure of the damages that global warming may incur, other than that they may be catastrophic, we may prefer permits to taxes, since the government can reduce emissions by a precise amount simply by issuing fewer permits.  That is, the permit system enables the government to control the amount of pollution more precisely than the tax system would.     

Eurasianet.org reports that Kazakhstani business leaders, “including KazEnergy, a powerful alliance of energy producers, is opposing the (permits) plan, arguing that it would stifle economic growth and decrease Kazakh global competitiveness.”  Hogwash.   By saving resources, the permit plan will stimulate growth and competitiveness, when compared to Command and Control. Moreover, the permit system encourages innovations that cut the cost of pollution control, since these increase the innovator’s profit from selling a permit.  If, for example, Plant B can reduce the cost of abating a carbon ton from $1 to $.75, then its profit from selling a permit for $2 increases by $.25.  Command and Control may not induce such innovation, because regulators usually require all polluters to adopt the best available technology.  The innovator will lose his invention to his rivals, so he is less likely to attempt expensive innovation in the first place.    What is costly for Kazakhstan is not the permit scheme but the original decision to reduce emissions.  Given that decision, the permit system is the cheapest way to go.

Eurasianet.org also reports “fears that the (Emission Trading System, i.e.,. permits) can prompt businesses to pass along higher costs to end users, spurring inflation and generating discontent in many communities.”  This argument is confused.  In the past, Kazakhstan exported pollution costs (in the form of global warming) to the rest of the world by permitting its power plants to emit carbon.  Requiring emitters to cut back merely recognizes that firms should pay for the input called pollution.  Undoubtedly a polluter will try to pass on this cost to customers; but since they have enjoyed the benefits of carbon emissions – such as abundant electricity – it seems fair to require them to pay the associated costs.  Anyway, users can avoid these costs by conserving. 

“Inflation” is a rise in prices throughout the national economy.  Technically, it’s the rate of increase in the “price level”.  A onetime increase in energy costs may push up the price level, but not forever.  So, the impact on inflation would be temporary.

Permits enjoy a political advantage over taxes.  Since the government must collect the tax revenues, it may be accused of adopting pollution taxes for financial rather than environmental reasons.  But it need not collect anything under a permits scheme:  It can allocate the permits for free and let their sellers keep the revenues.  Given Astana’s reputation for pecuniary cunning, this advantage is not rhetorical.         

--Leon Taylor, tayloralmaty@yahoo.com

Good reading

Larry E. Ruff.  The economic common sense of pollution.  The Public Interest.  Spring 1970.

Tom Tietenberg.  Environmental and natural resource economics.  Addison-Wesley.  Sixth edition.  2003. 

References

Khamidov, Alisher.  Carbon trade scheme fuels divisions in Kazakhstan.  Eurasianet.org.  July 9, 2013.