One of the policy implements we are currently testing for its efficacy, or lack of it, in containing global warming and reversing it is an emissions trading system (ETS) for carbon dioxide. In such a system, the total amount of permissible carbon dioxide emissions is specified at the outset. This amount is then divided into allowances (i.e. emissions permits) that are then distributed among industrial installations. (In principle, this distribution can extend to all entities whose market activity, directly or indirectly, produces carbon dioxide emissions.) If an industrial installation exceeds its allowances (i.e. its operations are not as efficient as they could be), then it must purchase additional permits from other more efficient installations. In this way, the ETS provides incentive to become more efficient.
The ETS is a bi-level control system. It combines top-down control in the total amount of permitted emissions and bottom-up control through the market behavior of those who or which trade in the distributed permits. The top-down control affords macrostability by ensuring that the collective conditions or objectives sought for by society are imposed at the outset to shape and select for the appropriate behavior among individuals. The bottom-up control affords microvariability as individuals, according to their particular circumstances, act accordingly within the constraint of the top-down control.
Of note in the top-down control exerted in the ETS is that it is social in nature: The total amount of permits generated is not determined by the market but rather by social concerns (instructed by the relevant science) about the adverse consequences of carbon dioxide emissions. Furthermore, the distribution of permits is not on the basis of ability to pay but on the basis of estimated or measured need. It is because the top-down control exerted is essentially social in character that it is disingenuous to claim the ETS as the market solution to global warming. It is because the total amount of emissions is specified at the outset due to social considerations wishing to avoid the adverse consequences of carbon dioxide that it is naïve to claim that it is immoral to hand out permits to pollute.
The ETS is actually not new. Also known as the cap-and-trade system (because of the cap placed on total permitted emissions), it has been in operation in the US for some years now to control sulfur dioxide and nitrogen oxides emissions. It has done a splendid job.
So why hasn't an ETS on carbon dioxide been set up in the US? Some of the concerns which have hindered such a development include uncertainty as how to how the initial allocation of allowances would work; the suspicion that the ETS would amount to energy rationing; and the apprehension that the ETS would disrupt the economy to disastrous effect.
These concerns have recently been disclosed to be without foundation. An MIT analysis (carried out by A. Denny Kellerman, a senior lecturer in the MIT Sloan School of Management; and by Paul L. Joskow, the Elizabeth and James Killian Professor at the MIT Department of Economics) commissioned by the Pew Center for Global Climate Change and involving extensive research funded by the Doris Duke Charitable Foundation has shown that the carbon dioxide ETS works efficiently and without harmful consequences to the macroeconomy. The carbon dioxide ETS involved-the first of its kind-is that of the European Union's. The European Union was forced to avail of the ETS because European leaders realized in 2000 that they would be unable to meet their obligations under the Kyoto Protocol (which would take effect in 2008) unless they did something quickly. Since previous attempts to reign in carbon dioxide emissions through a carbon tax had failed, European leaders reluctantly decided that they would have to implement an ETS in carbon dioxide. They decided to experiment with the system from 2005 to 2007 so that they would have it running by 2008.
The experiment-carried out in desperation-has succeeded well. Although, not expected to significantly reduce carbon dioxide emissions in this experimental phase, the carbon dioxide ETS did, in fact, effect those reductions. Furthermore, those reductions were effected with “minimal” disruption to the European macroeconomy. This achievement has been all the more remarkable because, initially, data on installation emissions were not available and could only be estimated, in many instances (overly generously, as it later turned out); and certainly because of the scale and heterogeneity of the European ETS: With $80 billion worth of permits to trade, it involved 11,000 installations distributed in 27 independent nations constituting “a loose federal union” differing “widely in per capita income, market experience, institutional background, and other features.” By contrast, the sulfur dioxide ETS in the US involved only 3000 installations and $4 billion worth of permits. No better evidence of the robustness of this union of macrostable top-down control and microvariable bottom-up control could be given.
This robustness is only underscored by another lesson learned from the experiment: that trading across time seems to make the system work even better. By trading across time is meant that installations can save some of this year's permits for use next year; or, conversely, they can borrow some of next year's permits for use this year and not have them available next year. The experiment found out that trading across time did not result in the inability of installations to present permits as they became needed.
Because of the robust effectiveness of the ETS as demonstrated in Europe, it is now conceivable, the MIT analysis concludes, that it might just provide the necessary model, not just for a US ETS on carbon dioxide, but one for the whole world. It may take 20 to 30 years, according to Ellerman, but the EU ETS would seem to be " “the sort of basic architecture towards which some sort of global climate regime would tend." ”
