Carbon Pricing

My AFR op-ed today is on carbon pricing, and the Liberals' volte-face on market mechanisms.
Liberate the True Liberals, Australian Financial Review, 1 March 2011

In 1989, when US President George HW Bush proposed the use of market-based mechanisms to deal with acid rain, electricity generators warned that costs would skyrocket. Today, the program is universally regarded as a success, achieving its emissions targets at around one-third of the projected costs.

Why are market-based mechanisms so much cheaper at cutting pollution? In the case of acid rain, researchers found that firms used a variety of approaches to reduce emissions. Some retrofitted emissions control equipment. A number switched to cleaner fuels. Others retired their dirtiest generators. Because each firm took the lowest-cost approach to abatement, the social cost was minimised.

For environmental economists, this result merely reaffirmed theoretical work going back to Arthur Pigou in the 1930s and Ronald Coase in the 1960s. By the time Coalition climate change spokesman Greg Hunt won a prize for his 1990 university thesis on ‘A tax to make the polluter pay’, the economic theory was widely recognised. Hunt pointed out that ‘An attraction of a pollution tax regime is that it produces a strong incentive for firms to engage in research and development’. For consumers, ‘goods which do not generate [pollution] in their production will become relatively cheaper and therefore more attractive’.

Discussing the politics surrounding pollution taxes, Hunt argued out that ‘a pollution tax is both desirable, and, in some form, is inevitable’, but acknowledged ‘even if some of the Liberal’s [sic] constituents do respond negatively, a pollution tax does need to be introduced to properly serve the public interest’.

The purpose of quoting Hunt’s thesis is not to play some form of ‘gotcha’ game, but because it represents the view that most small-L liberals have held for decades. The UK Conservatives are proud champions of their nation’s emissions trading scheme. As recently as 2007, the Liberal Party of Australia’s election platform promised: ‘To reduce domestic emissions at least economic cost, we will establish a world-class domestic emissions trading scheme in Australia (planned to commence in 2011).’

To provide certainty, the Gillard Government proposes to start with a carbon price (in which the market determines the quantity of pollution), before transitioning to a fully flexible emissions trading scheme (in which the market determines the carbon price). Both have the advantage that they allow millions of households and businesses to find the most cost-effective way to reduce carbon pollution. For the first time, it also becomes profitable for entrepreneurs to find ways to reduce carbon emissions.

Because the arguments for harnessing markets to cut carbon pollution are essentially the arguments for free markets themselves, the opposition to emissions trading has historically come mostly from the left of the political spectrum. Yet today, we have the odd spectacle of a supposedly market-friendly party advocating a climate change policy that looks awfully like command-and-control. If you think that we can cut smoking rates more effectively by subsidising celery sticks than by taxing cigarettes, you’ll love Tony Abbott’s Direct Action plan. On one estimate, the only way the Coalition can meet its own emissions target is by spending many billions buying permits from other nations.

Among many in the Coalition, a commitment to markets is frighteningly fragile. Sitting in House of Representatives these days, I sometimes feel as though I’ve passed into a parallel universe in which Labor is the only true defender of free market economics. In recent months, Coalition MPs Michael McCormack, Ken O’Dowd and Karen Andrews have called for protectionism for agriculture, fishing and surfboards respectively. George Christensen believes income taxes – one of the government’s most efficient sources of revenue – should be abolished.

One of the essential lessons from first year economics is that the best way of addressing a negative externality is to put a price on it. But getting the design right will be critical. For households, we need to craft an appropriate assistance package. For businesses, it will be vital to ensure that emissions-intensive trade exposed industries can remain competitive. And for energy generators, it will be important to provide certainty as they go about transforming themselves into cleaner producers.

As it deals with these issues, the Multi-Party Climate Change Committee could doubtless benefit from the ideas and experience of many in the Coalition – if only they were allowed to participate. Let’s hope Mr Abbott takes the chance to constrain his conservatives and liberate his liberals.

Andrew Leigh is the federal member for Fraser.

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