The Economics of Climate Change: Cap-And-Trade Scheme, Research Paper Example

Over the last decade, global warming and climate change has emerged as a significant environmental, political, and economic issue in various discourses. An ongoing dialogue involving corporations, politicians, environmental groups, and individuals across the globe has both opposed or supported various ways to price greenhouse gas emission such as carbon dioxide. Within the U.S, various competing economic paradigms and methods continue to be debated regarding which is the most efficient mode of pricing. Incessant opposition, however, continues to question the facts and contends that climate change is a political fabrication that has no credence or validity in scientific fact. Three major camps have emanated from this ongoing dialogue: do nothing, cap-and-trade, and carbon tax. Through a macro-economic analysis, the camp-and-trade approach has emerged as the most prudent course for capping the emissions of greenhouse gasses once taking the positives and negatives of the approach into account. Cap-and-trade is a regulatory instrument that is widely deployed to bridle greenhouse gas and other forms of pollution that has recently been castigated for yielding only minimal reductions of intended emissions.

According to the Environmental Protection Agency of the United States of America(EPA), cap-and-trade refers to an environmental practice that delivers positive outcomes for the reduction of carbon emissions by placing a mandatory cap on them while also providing sources flexibility in how businesses and industries comply. Successful cap-and-trade policies and programs reward efficiency, early action, and innovation and implement stringent environmental accountability without stunting economic growth and prosperity (Miller 479). There are various examples of successful cap-and-trade policies implemented not only in the United States but worldwide. The Acid Rain Program, which was a nationwide policy, as well as the Budget Trading Program, which was a regional policy in the Northeast, were both considered successful programs. In addition, on March 10, 2005, the EPA passed the Clear Air Interstate Rule (CAIR) in order to build on the momentum of the success of the two previously named programs in order to significantly reduce carbon emissions.

The Cap-and-Trade Environmental program, in the same fashion as other environmental policies, concentrates mainly on analyzing and assessing why and how people render decisions that directly impact the natural environment. Individuals, industries, and firms often pollute the natural environment through various business practices because it remains the cheapest way to solve a variety of practical problems while yielding high profits. Disposing waste products after consumers have used materials such as plastic or glass, or after industries and firms have finished manufacturing goods, are two ways such pollution materializes (Field and Field 45). Such decisions are made within a particular set of social and economic institutions, and various institutions structure and present various incentives that lead firms and industries to render decisions that are either economically or environmentally-oriented. From this perspective, providing incentives has emerged the most effective way of mitigating environmental pollution and carbon dioxide emissions because of the profit-driven mindset so prevalent in the business and mundane world today. Carbon dioxide emissions in the atmosphere immensely contribute to pollution and result from the production and consumption phases in particular business sectors such as agriculture, energy, industry, transport, and land use changes, in addition to others that have been pinpointed as major contributors to global warming that would have massive global ramifications both for ecosystems and people. Placing a global price on carbon dioxide emissions as a result of a cap-and-trade carbon emission scheme on a global level will provide firms across the world incentives to diligently look for ways to produce an economic output with minimal quantities of inputs that are environmentally harmful or to switch the fuel utilized so that smaller amounts of carbon dioxide are emitted. If emissions fall under the set cap allowance, then they would receive extra profit credits, thereby incentivizing them to continue environmentally practices in the future. Such a scheme would also result in price increase for goods that need more energy to produce in comparison to those that require less relatively. As such, consumers would be incentivized to alter their consumption behaviors and patterns. Such a scheme requires equity, efficiency, incentives to maintain such a scheme in the long run, cost-effectiveness, and enforceability must all be taken into account in order to assess its efficacy and productivity from a macro-economic perspective (Field and Field 3).

Equity, Efficiency, And Cost-Effectiveness of Cap-And-Trade Schemata: A Positive Approach

The global warming equity objective focuses on placing the burden of emission reductions on developed, wealthy, industrialized nations that have been at the fore of conducting anthropogenic activities contributing to the emission of greenhouse gasses. Placing the cap is the most significant yet difficult part of implemented a global scheme because it means that a new property right must be created and include a permit to emit carbon dioxide. The total amount of carbon emissions refers to the upper limit of a nation and germinates from the total number of unit permits. These discharge permits can be transferred between countries and firms and could be purchased at a price that the participants agreed to.  Thus, in this equity step, the amount of emission reductions have to be taken into consideration. Indeed, while climate change is a global problem and must be broached as such, industrialized countries have been the main contributors to exacerbating climate change and also possess adequate resources to tackle it. Developing nations remain at-risk to the negative ramifications of climate change, and they lack the institutional, technological, economic ability to respond to or address it. Thus, the equity principle calls for developed countries to utilize their technological and financial resources in order to reduce and stabilize long-term carbon emission patterns and trends. Moreover, they need to shoulder the responsibility of aiding Third World countries deal with climate change and make the necessary adaptations.

Beyond the equity principle, the efficiency and cost-effectiveness of a cap-and-trade scheme must be taken into account in order to assess the efficacy of it as a model for combating climate change on a global stage. According to macroeconomic theory, excessive pollution levels take place because of market failures. Such failures include imperfect data, the public goods nature of environmental health and quality, among other factors. As such, economic theory postulates that governments possess the duty to intervene in order to provide firms and individuals incentives for the reduction and control of pollution levels. Ascertaining optimal levels of pollution control calls for extensive analysis of environmental externalities that were being produced due to various economic activities. An environmental externality refers to a cost or a benefit that has not be accounted for according to environmental regulations and stipulations either by consumers or a producer of a certain activity (Miller 480). One example of an externality is a firm such as a paper mill that emits pollution into the groundwater, thereby polluting bodies of water and possibly impacting a nearby Native American village that depends on fish or other food sources yet suffers because the pollution has despoiled such food sources. Drinking water is also contaminated, and a noted decline in fish population as well as in recreational swimming would result. Such negative externalities, or costs, must be accounted for at the behest of individuals or firms. If such negative ramifications fail to be reflected in the production costs of firms, and therefore in the market price of a particular economic activity by producers, then the firm will be responsible for pollution emissions that far exceed the social and environmental optimum.

In order for external costs to exist, two conditions must be present: the activity of one party causes another party to experience a degradation of welfare; and the party that experienced the loss of welfare goes uncompensated. The abatement of pollution would yield lower costs if initial emission reductions are implemented, and every marginal unit of pollution control would be more costly then previous units. Therefore, the curve of the Marginal Abatement Cost (MAC) becomes more steep as the number of emission reductions escalate. The desired level for pollution control is reached once the MAC is equivalent to the Marginal Social Benefit, which requires environmental regulation authorities to constrain the aggregate level of emission reductions and reflect the marginal costs correlated with the economic activity levels.

Cap-and-trade policies are more preferable and considered superior to traditional command and control schemes for environmental regulation because the cap, which establishes the emissions target, is attained via the trading of the allowances, which yields minimal economic costs. The environmental regulation authority decides the number of emissions allow and puts in place various allowances for the determined amount. Such allowances are subsequently allocated to various sources, which are able to trade with others operating in the allowance market. In this scheme, firms and various nations that retain low abatement costs will choose to reduce their carbon emissions in a way that far exceeds the allowances they possess, thereby selling the extra allowances to countries and firms that have higher abatement costs. Therefore, abatement costs are equalized across all sources involved, and the costs of reaching the stated environmental target are greatly reduced.

A cap-and-trade policy puts a price on pollution, which forces firms to reduce emissions and costs through technological innovation vis-a-vis a strong economic incentive. A set cap forces firms and countries not only to attain lower allowances but also to reduce carbon emissions in order to earn profit credits for staying under the cap, thereby yielding greater profits. Allowances are extremely profitable, so cap-and-trade policies provide firms with persistent incentives to adopt low-cost emission reduction opportunities. In addition to limiting carbon emissions, the cap also produces an economic market for carbon emission allowances where a certain unit of carbon emissions has a set price. The price provides incentives over a protracted period of time for the development of new business technologies that will ultimately mitigate greenhouse gas emissions (California Market Advisory Committee).  Enforcing the compliance of pollution emission allowances continues to pose drawbacks for a cap-and-trade scheme. Monitoring and reporting are vital for any market-based or economic mechanism, including the reduction of carbon emissions, need to be measurable, verifiable, and transparent. Such activities in addition to control and verification are critical for such an economic scheme to maintain integrity and economic currency.

Equity, Efficiency, And Cost-Effectiveness of Cap-And-Trade Schemata: Drawbacks And Rebuttal

Economists and analysts have historically advocated that cap-and-trade schemes for the reduction of pollution and carbon emissions point to evidence that shows such regimes spawn reductions in a cost-effective manner of carbon dioxide as well we for other conventional ones like sulfur dioxide (Johnston 429). The efficacy of such schemes is generally autonomous from permits that are initially administered for polluters, which may, to many businesses and economists, seem to be the most embraced mechanism for cost efficiency and efficacy for mitigating the emissions of greenhouse gases on an international scale that continue to exacerbate climate changes at a rapid rate (Johnston 429). The same can be said for cap-and-trade schemes at the national level. Domestic cap-and-trade schemes for traditional pollutants. As such, the fairness and efficiency of global cap-and-trade schemes to reduce greenhouse emissions rely on the homogenous enforcement  of the set caps and “verifiable, real emission reductions” (Johnston 430). Evidence and economic theory intimate that international schemes lack uniform reduction or verification that greenhouse emissions are verifiable (Johnston 430. As such, critics of the cap-and trade scheme point to the lack of homogeneity in the enforcement and verifiability of firms and countries complying. These blaring discrepancies must have correctives implemented in order for such schemes to work.

Conclusion

By examining and assessing the empirical record of cap-and-trade as a model for reducing emissions for the past two decades, it is evident that emission targets have been reached in a cheap and efficient manner because of changes in economic output; generous targets; innovation; price movements; and complementary emission reduction practices. The overall failure that has been witnessed thus far to accurately anticipate mitigation potentials most likely correlate with a psychological “end of history bias” because economic analysts and policymakers believe that change will not materialize in the future then has already demonstrably transpired in the past. As such, it is unequivocal from a macro economic standpoint that abatement is still possible in a more cost-effective manner than has generally opined, thereby rendering the prices of carbon emission permits much more difficult to anticipate. Regarding climate research and the onset of a heated political dialogue on the phenomenon of global warming, general findings suggest that various emission schemes assuming increasing pollution prices will prosper from integrating cap-and-trade regulations with empirical results. From a policy perspective, mechanisms including floor prices must be taken into consideration in order to assure that emissions will be reduced sans uncertainty.

Works Cited

California Market Advisory Committee. Recommendations for Designing a Greenhouse Gas Cap-and-Trade System for California. California Market Advisory Committee. 2007.

Field, B., and M. Field. Environmental Economics, an Introduction. Third Edition. McGraw-Hill Higher Education, 2002. Print.

Johnston, Jason Scott. “Problems of Equity and Efficiency in the Design of International Greenhouse Gas Cap-and-Trade Schemes.” Harvard Environmental Law Review, 31, 405-433.

Miller, G. Tyler. Living in the Environment: Principles, Connections, and Solutions. United States: Brooks/Cole, 2005. Print.