2.1. Targeting and objectives
A first issue with emissions trading concerns the objectives to be pursued. A trading process, in itself, offers no benefit to, say, the environment. It does not reduce greenhouse gas emissions. What it does do is to provide a way for a given target to be achieved at lowest cost. In a cap and trade system, it is the setting of the cap that provides the opportunity for imposing limits on, say, environmental pollution. Within a baseline and credit regime, it is the setting of the baseline. Proponents of emissions trading would, however, argue that emissions trading systems offer highly implementable ways of reaching whatever targets are decided upon and that they lend themselves to strategies for tightening controls as trading takes place (Stern 2007, ch. 15).
It should be noted here that, in meeting targets with a trading device, much depends on the mode of defining emissions and distributing allowances. If emissions are defined absolutely (i.e. an absolute limit to discharges is set) this targets environmental objectives directly. If, however, emissions are defined relatively (as limits per unit of production), increases in levels of productivity may produce overall increases in emissions even when there is full compliance. (The same would be true of a command system imposing design standards.)
Are emissions trading systems amenable to the institution of environment enhancing targets? Experience with the European Union Emissions Trading System (EU ETS) points to a set of potential challenges to be faced – and, notably, to the difficulties that are experienced when allocating not through auctions but by means of governmentally established entitlements (Convery & Redmond 2007; Ellermam & Buchner 2007; Kruger et al. 2007). Crucial in the EU ETS were the initial allocations or “allowances” for Phase 1 of the regime in 2005–2007. Incumbent enterprises were extremely concerned to generate generous allowances that would minimize any potential costs, and the emissions trading directive left it to Member States to establish allocation plans. As a result, intense lobbying ensued across the EU so that: “[I]n most cases, these efforts resulted in lax emissions targets, complex special allocations to powerful interest groups and, in some cases, even in an over allocation compared to actual emissions” (Butzengeiger & Michaelowa 2004, p. 118; Svendsen 2005; Open Europe 2006; Convery & Redmond 2007).2
Additionally, implementation timescales were tight in the EU ETS and a complex set of allocation rules had to be worked to. As a result, it can be argued, powerful interests were able to exploit their informational advantages to keep the constraining effects of the ETS at bay (House of Commons Environmental Audit Committee 2006–2007). For example, Greenpeace protested:
Governments massively over allocated CO2 permits as the market crash in the carbon price has shown ….(the price fell by more than 60%)….it was because the system relies on future emissions projections as a method to set a cap and then gives out permits for free. Industry simply inflates its own emissions projections in order to ensure it maximises the number of free permits that it gets – permits that, once allocated, have a significant market value. (Oakley 2006)
The pressure group dubbed this “a license for polluters to print money” and the German environment minister reported that the EU’s four largest power producers had profiteered from the ETS at the expense of consumers – and had stoked their earnings by €6bn–8bn (IPA Consulting 2005; Gow 2006; Open Europe 2006).
When the UK revised its EU ETS National Allocation Plan for the post-2007 period, its proposed cap on emissions for Phase 2 of the ETS was higher than for Phase 1, prompting environmental pressure groups to accuse the UK government of repeating its over-allocation of permits to the detriment of consumers and the environment (Greenpeace 2006).
The EU experience raises doubts about the amenability of some emissions trading systems to the progressive adjustment of targets in order to improve environmental protections. Command systems have been criticized on this front (Ackerman & Stewart 1987, p. 174) but it can be argued that emissions trading regimes are similarly beset by difficulties of complexity, uncertainty, and delay when approaching the revision of standards and limits (Driesen 1998a, 2003). There will also be lobbying difficulties and pressures from potential litigants; these are likely to prove to be at least as severe as those encountered in traditional command regimes.
The message to be drawn from the EU ETS is that if allowances are distributed at no cost, there are serious incentives to distort emissions projections so as to create windfalls. One answer to this problem is to allocate allowances by means of auctions. If auctions are competitive, polluting enterprises will calculate their abatement costs as accurately as they can and then: (i) take steps to abate where this is cheaper than purchasing permits; and (ii) purchase permits to cover production up to the point of non-profitability. Many “grandfathered” firms will, of course, object to having to pay for emissions that previously had been discharged at no cost. Auctioning, however, can be defended on the grounds that, not only does it avoid dangers of manipulation, but that polluters and the consumers of polluting products should have to pay for the harms that they inflict on the environment.
2.3. Is emissions trading fair?
A fundamental problem with market-based systems of distribution is that such systems have an inherent bias in favor of those parties who possess wealth and they tend to remove power from those who lack resources. The results of trading may be claimed to be cost-effective but this does not ensure fairness (OECD 2002, p. 20).
A first difficulty with trading systems is that, if they are to overcome the political hurdles of inception, they tend to have to “grandfather” existing operators into the system (OECD 1998, p. 39; Raymond 2003). If, however, permits to pollute are allocated on the basis of historical or current emission levels, polluters will not “pay”. They will be rewarded for their records of pollution and will be positioned so as to be able to maximize their rewards by exploiting their informational advantages and abilities to manipulate data to their advantage (Baer et al. 2000; Neuhoff et al. 2006; Open Europe 2006; Stern 2007, p. 333).4
Free allocations, moreover, may result in windfall profits. As Stern commented, “Not surprisingly, free permits are generally favoured by existing players in industry” (Stern 2007, p. 333; von Malmborg & Strachan 2005).
Fairness, Stern added, demands that historical polluters are not simply rewarded but should pay a greater share of abatement costs (Stern 2007, p. 472). The difficulty with this argument is that such redistributive approaches always tend to be countered by the regressive effects of trading systems. As for comparisons with other regulatory methods, such as command and control, it has been argued that most empirical studies find that, across a range of policy instruments, the costs of control tend to be borne disproportionately by poorer groups – but that this is especially the case with grandfathered emissions permits (Parry 2004; Parry et al. 2005).
Nor do fairness issues disappear if permits are allocated by auctioning rather than by free allocation. Auctioning favors those incumbents who have the existing resources to make successful bids. The principled objection here is that it is unfair that incumbent polluters – who have accumulated wealth at the cost of the environment – should be better positioned than non-polluters or new entrants to the field.
Such unfairness can result in barriers to market entry (Hahn 1984) and small and medium enterprises may also complain that they suffer competitively because they are far less able than large companies to deal with the extensive administrative and informational burdens that are involved in negotiating allowances or organizing bids for permits (Butzengeiger & Michaelowa 2004). On the international stage, it has similarly been argued that: “Only big firms can afford to hire carbon accountants, liaise with officials and pay the costs of getting projects registered with the UN. Yet these are often the companies that local people battle hardest against in defense of their livelihoods and health” (Lohmann 2006).
Post Kyoto, a key issue is the development effect of trading systems (Richman 2003). Internationally, emissions trading solutions have been said to involve a double injustice. The effects of existing emissions are felt disproportionately by the less developed nations and they restrict development over coming years. Trading has been called “colonialism with a modern face” insofar as it perpetuates and deepens inequalities of access to and control of resources (Rising Tide 2006). Critics protest that trading allows wealthy countries and companies to escape their historical responsibilities for greenhouse gases, to avoid making emissions reductions in their own operations, and to “defraud developing countries of their rights to use of the global atmosphere” (Christian Aid 2002).
The charge, then, is that historically based allocations allow currently high emitters to impose environmental damage on other countries and to lock the less developed nations into lower levels of development. The linked concern is that in the early years of trading, the mechanism allows existing industrialized users to meet their targets at lowest cost and to avoid making reductions in home emissions. When, however, developing countries become faced with emissions targets themselves, the cheapest forms of emissions abatement will have been exhausted and only more expensive high-tech forms will be left – at which time industrialized countries will be unwilling to invest abroad. In short, industrialized countries will have gained preferential use of lowest cost abatement methods and reaped a competitive advantage while suppressing development (Christian Aid 2002, p. 7; Richman 2003). Supporters of emissions trading might argue that such considerations can be taken into account when allocations are negotiated; but this response makes assumptions about the bargaining power and positions of developing countries (or the altruism of developed countries) that may be unrealistic – a matter to be returned to below.
A central concern regarding global fairness is that developing countries cannot reasonably be expected to restrict their future emissions without being assured of a fair allocation scheme that will not impair their ability to develop (Aggarwal & Narain 1991; Baer et al. 2000). This demands, it can be said, not historically based or auction based distributions but allocations based on equal rights to the atmospheric commons for every individual.
A further argument, however, suggests that, from a development point of view, it is not enough to allocate emissions rights on a per capita equal rights basis. The effect of this would be to allow existing wealthy polluters to purchase, from poor permit holders, sufficient allocations to allow them to continue to trade at profit maximizing levels. There would be a one-off transfer of wealth to poorer firms but these less wealthy players would be paying a price for that transfer – in the form of forfeited opportunities (Mehmet 1999; Richman 2003, pp. 149–154).
Informational asymmetries would be likely to exaggerate this effect (Gupta 1997; Richman 2003). To take an example, let us suppose that it is decided internationally to cap pollution from air travel and to do so by establishing a trading scheme in which all companies are allocated x hours of flights per year (size of allocations to reflect numbers of employees). Wealthy Company A, from a developed country, would, say, purchase the emissions allowances of less developed companies B, C, and D. Would the price paid reflect the true wealth generating potential of those allowances? It is unlikely to do so because not only has Company A a greater capacity to develop that potential (which is what makes the system efficient) but it has superior information about that potential.5 Companies B, C, and D, moreover, are likely to suffer from non-informational factors that will further undermine their abilities to strike satisfactory deals with Company A. Notably they are likely, if sited in a developing country, to be competing, as sellers of allocations, with firms that are less well informed, less rational, and more desperate to sell. The overall effect of allocations trading on Companies B, C, and D is that they receive a one-off payment (a suboptimal one) and, being excluded from air travel, they will have restricted development potential and are likely to be left ever further behind in the marketplace by Company A. The propensity of companies B, C, and D to opt for the short-term profit at the expense of the longer-term gain is, furthermore, consistent with the message from the risk literature that actors tend to discount the future effects of their actions (Cropper & Portney 1990; Viscusi 1992; Graham & Weiner 1997).
According to Stern, one of the major advantages of emissions trading systems is that they allow efficiency and equity to be considered separately (Stern 2007, p. 473). The UN Framework Convention on Climate Change (UNFCCC) approaches this issue and argues that developed countries should show leadership in tackling emissions, transferring technology, supporting capacity building, and financing the incremental costs of emissions reductions.
These may be sentiments worthy of support but we should be clear about the degree to which emissions trading and reallocative policies pull in opposing directions (Richman 2003). Such a tension may be so severe as to lead cost-effectiveness concerns to swamp those of equity – which negates Stern’s argument that emissions trading conveniently allows equity and efficiency issues to be considered separately. Thus, it has been argued that: “Emissions trading may conflict with the post-Rio developed country leadership principle in several ways. Most obviously, it allows developed countries to claim that they are meeting their reductions obligations through trading and to ‘double count’ trades as both domestic reductions and assistance to developing countries” (Richman 2003, p. 170).
Emissions trading exaggerates the effects of inequalities in wealth distribution and offers up wealth creating opportunities to the currently wealthy (and often polluting). Reallocative policies, when linked to emissions trading, may look transparent and worthwhile, but three points are worth stressing. First, any reallocative virtues will be due to distributional decisions and restrictions that are placed on the trading mechanism – not to the trading mechanism itself. Second, any protections for the less well off, less powerful, less developed and less well informed will be operating within a system that is intrinsically skewed in favor of wealth holders. Finally, it can be argued that, as far as fairness is concerned, there are grounds for doubting whether emissions trading systems match up to the performance of command or taxation regimes. The latter, after all, offer across-the-board controls, are generally more easily enforced from the center and are not so vulnerable to distortion in favor of the well resourced.
2.4. Is emissions trading accountable and transparent?
It has been argued, as noted above, that emissions trading combines democratic accountability with a market mechanism and that trading focuses public attention on decisions about aggregate emissions reductions (Ackerman & Stewart 1987). In this regard, it is claimed that emissions trading can offer more democratic accountability than the rulemaking processes of traditional command regulation. Skeptics, however, argue that trading systems have a special complexity that does not facilitate access. Such systems, it is complained, overlay market processes on top of the standard setting procedures usual to command regimes. This duality, it is said, makes citizen participation in emissions trading programs more difficult than in traditional regulation and renders such programs highly vulnerable to industry lobbying (Driesen 1998b; Lockwood 2007, p. 7).
Special criticisms may apply to systems, such as the EU ETS, in which caps are set in relation to BAU projections. As noted above, such approaches mean that the caps imposed on emissions are liable to change as firms change their forecasts of emissions – a process that has been said to create an obvious lack of transparency that underlines the need to set reductions from an absolute level of emissions, rather than from a baseline of BAU projections which may vary significantly according to the differing assumptions that are fed into them (House of Commons Environmental Audit Committee 2007).
Accountability to whom is, of course, also a key issue, and one of the recurring criticisms of carbon trading post Kyoto is that it makes policy-makers responsive to multinational corporations, not local populations (Wall 2006). The emissions trading device, moreover, involves a lack of accountability by public officials for the distributional decisions of the market in allocations – regarding, for instance, the location of the steps that are taken to abate emissions or the competition consequences of allocations. The emissions trading process, as a result, helps such officials to avoid specificity about the policies being furthered through the trading mechanism and the distributions of costs and benefits, winners and losers (von Malmborg & Strachan 2005). If, moreover, trading is allowed across jurisdictions, there may be the additional problem of perverse incentives. The purchasers of permits may be induced, by emissions trading, to purchase credits from countries that monitor credit generating activity poorly. Monitoring in such countries will tend to be particularly weak if the pollution at issue is not inflicted on that country specifically but is spread across nations as a “common bad”– as with greenhouse gases (Mabey et al. 1977, p. 25; Driesen 1998a, p. 15). Such weak monitoring systems will undermine accountability, and transparency will be especially poor.
How, then, does emissions trading score on general transparency? One way to summarize this issue is to evaluate emissions trading processes with reference to Stirton and Lodge’s four key transparency mechanisms (information, choice, representation, and voice) (Stirton & Lodge 2001). Information allows informed choices by consumers and others but, as noted, emissions trading supplies little information to the consumers of products regarding the emissions abating efforts of suppliers and manufacturers or the locations at which any abatement efforts are being made. Choice allows consumers to choose the nature of products and goods – but, again, the lack of information provided to consumers in emissions trading systems means that purchasers of products are ill-placed to choose between polluting and non-polluting products. Representation ensures transparency by allowing access into policy processes to user and interest groups. With emissions trading mechanisms, however, such access is conferred predominantly on those suppliers who buy and sell permits; other groupings are, in the absence of disclosure regulation, kept at a distance by their non-inclusion in the market. Voice allows user participation and redress. Unfortunately, however, the consumer of goods has no access to the trading market, and the processes used to set caps and baselines tend to be dominated by conversations between supply firms and governments. Overall, then, serious doubts arise concerning the general transparency of emissions trading processes – at least to ordinary consumers.