Monday, February 08, 2010

Bob Frank on Coase and Cap and Trade

Bob Frank is one of my favorite Economists - Here is his take on Coase and Cap and Trade.


Ned said...

I think we still have a long way to go in terms of figuring out what is a reasonable cost/price of carbon emissions. One of the largest troubles is determining how much damage a unit of CO2 actually does. Once you consider where this carbon actually goes and how long it stays there, its hard to define its damage. This uncertainty about external costs related to emissions can be interpreted as uncertainty about the emissions themselves (whether they can or are doing any damage). I think that regardless of the price we put on emitting a certain amount of carbon, the system we are trying to protect is too complex for normal cap and trade to be applied appropriately.

Andrew said...

Another interesting overview and application of Coase. The comment about markets failing because we "don't take into account the costs that our carbon dioxide emissions impose on others" also intrigues me. I think that this is one place Ned's comments come into play. If we don't really know how much damage we are doing, it seems almost impossible to take into account the costs imposed on others, as well as the cost/price of emissions.

Taylor said...

The difficulty in coming to an agreement regarding the solution to global warming stems from our inability to definitively calculate the costs of global warming/ CO2 emissions in relation to the benefits of unregulated CO2 emissions. This negative externality could be solved by cap and trade or taxes on emmissions,but both measures face opposition in Congress due to the fact that we don't really know how much damage we are doing to ourselves and the environment. I think taxes on emissions is a better policy because taxes are easier to apply to both industrial and personal emissions; also, the government wouldn't have to worry about issuing too many permits.

Pearson Nibley said...

Frank's article is very well written and certainly makes Coase an even more interesting economist to study. Since CO2 levels are so hard to track and measure, we therefore cannot know the precise level of transaction costs necessary to solve carbon emission disputes. As Frank writes, this is why even Coase feels we need some sort of Government intervention. As we talked about in class with the case of the European Union, I feel that Cap and Trade is not the right policy to employ in case we over-issue permits as the EU did. Implementing a tax on emissions would be easier to do than Cap and Trade and we wouldn't have to worry about the problems of permits.

stuttsb said...

Most discussion about greenhouse gas regulation mentions only CO2 regulation. Are the cap & trade and tax proposals for only CO2 or also other greenhouse gases (CH4, N2O, and fluorinated gases according to EPA)? I suppose this is because CO2 has been the main increasing emission (at least in the US), but I wonder if CO2-only regulation might cause perverse incentives to increasing CO2 abatement at expense of CH4, N2O, or fluorinated gas emission abatement. Are these other gases already sufficiently regulated in the US? What about in other countries?

Regarding Ned's comment about the uncertainty of damage costs, I think we should still go ahead with instituting either a cap & trade or tax system for greenhouse gases, estimating the correct level as best we can, and correcting as new information comes to light, so long as the marginal damage costs are significantly above zero (at least worth administrative costs?) and if we are risk averse. Since the damage costs are likely high, the current emissions price of zero is too low. The Stern Review's 2006 "The Economics of Climate Change" estimates yearly costs of 5-20% of GDP worldwide from warming (and abatement costs of 1% of GDP worldwide. If this study is roughly accurate, it is certainly worthwhile at the global level to price greenhouse gases above zero.

Either tax or cap & trade is more efficient than command & control or nothing.

Michael said...

What I like about this article is that it portrays Coase as he economist. He is not a politician and therefore does not entirely follow the modern conservative thread. His agreement that either cap & trade or taxing carbon is a hope for the future. The effects of CO2 on the world are undeniable, the problem is that no one can seem to do anything about it yet. Maybe if more high profile people can argue the case, the staunch conservatives can see that a moderate approach is the best for society. Since there are always transaction costs and there are always externalities (even if they are not immediately apparent) there is no possible way that the situation will just take care of itself. It is time for action and the fact that a 100 year old economist agrees shows that it's about time for policy to catch up to economics.

boehlinga10 said...

I agree with Michael in that the article really provides an economist's view of the current policy issue. Coase does not dance around the issue and provide a solution simply to please one party or the other. He seems to have a very straight forward approach to the problem, which involves government intervention: "Those with inexpensive ways of reducing emissions will find it attractive to adopt them, thus avoiding carbon dioxide taxes or the need to purchase costly permits. Others will find it cheaper to pay taxes or buy permits." Whether a tax or a cap and trade system is implemented, I feel like there will be a "survival of the fittest" effect where only the most cost efficient, low emission firms will remain in the market. It is important for the government to intervene because, as many have already commented, it is difficult to measure the marginal effect of CO2 emissions. That being said, it is also difficult for negotiations to be made among the "perpetrators" and the "victims."

Jarrett W. Brotzman said...

I agree with the use of taxes or permits of pollutants in order to reduce the total amount of damage an individual does to a group of people (a population or society as a whole).

One important distinction this article makes that free markets make the most efficient solutions in a market that does not have significant transaction costs. As the article points out, however, frequently are prohibitive to free transactions.

One interesting point that the article made that I did not think of before was that, "as Mr. Coase suggested, government regulators should try to mimic solutions that people would have adopted on their own if negotiations had been practical."

The issue I find with this, is that not all industry or business has equal access to the legislatures that make the rules for the distribution of the credits. However, if the distribution of credits were determined through a fair market bidding system without preferential treatment for ANY industry, than I could see the system working very efficiently.

Katie Bean said...

Coase argued that if property rights are well defined and transaction costs are low, a market will develop for the externality – ultimately reaching an efficient solution, where costs are minimized. It is clear that in the case of carbon emissions and global warming, property rights are unhelpful, as pollution is not confined to a localized area, and transaction costs are high because so many parties exist– both polluters and those affected by pollution. Since private bargaining is not feasible, collective action is necessary to combat carbon emissions. This will be seen through government intervention.

Economic incentives, either a tax or cap and trade system, offer the best solution to this problem as they alter people’s incentives. In the end, abatement is accomplished by those who can do so at least cost, reducing the externality in an efficient manner, as Coase proposed. However, problems remain. The cost of carbon and emissions is difficult to calculate, and a plan to cut and regulate emissions and must be proposed. These issues must be worked out and be presented in a viable policy proposal. The economic incentives should spur innovation for new technologies and methods to reduce emissions, but additional funds should be provided for R&D.

Ultimately this policy alters the time horizon of costs and benefits; costs that are inevitable in the future will be partially borne now, and benefits will be decreased now, but will continue to exist in the future. The solution should mirror what the market would have achieved without the externality, as the externality is eliminated through costs being internalized.

Chas said...

Many people have expressed concern about the practicality of assigning a monetary cost to a unit of carbon emission. There is no way to perfectly determine the cost of emissions, yet the inability to determine cost cannot be an excuse for inaction. A foundation for determining costs of emissions would be to start with a hedonic pricing technique that looks at the relationship between air quality and housing prices. The positive relationship (high priced houses are associated with cleaner air) can be used to determine a baseline for the price of carbon emissions. Other techniques can be used to determine other costs of carbon that can be added onto the baseline until we reach an acceptable price of carbon emissions. At this point it would be best to use this price, understanding that it is not perfect, and implement a cap and trade or a tax policy. The uncertainty regarding some of the future effects of high carbon emissions is too great to not take this problem seriously and take action now.

Aparajita said...

The problem of global warning is a good example of thinking about negative externalities and the best way to deal with it. The regular approach would be to analyze the marginal cost and marginal benefits of carbon. emission. The optimal level of emission will be at the point where the costs from emitting an extra unit of carbon is greater than its benefits.But as others have said in their posts, the problem is determining the costs of carbon emission. It is hard to put a monetary value on things for which no market exists. How do we put a value of environmental damage, air quality damage and ecological damage.The uncertainty about costs is always an important thing to keep in mind when we are thinking about tax vs. cap and trade system for curtailing carbon emission. Since we do not know the right total cost of emission, we can either chose a fixed price/cost of emission or quantity of emission (which might after all not be the optimal level). Hence in order to chose between the two we need to decide which one of the two quantities do want to fix.

Jarrett Smith said...

This article emphasizes the importance of decision makers to properly interpret and understand basic economic principles. I'm glad the author was able to meet directly with Coase and have him clear up some of the confusion.

The article mentioned how the externalities associated with CO2 emmisions are practically impossible to escape. In addition there is no current market for clean ozone layers, good water quality, etc. Such circumstances call for government intervention so cooperative collusion can take place.

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Stephanie Beebe said...

I think it is interesting that the author points out that critics of cap and trade and carbon taxing including conservatives believe it is a form of "social engineering." It is funny to me that taxes on carbon can be construed as social engineering and a violation of liberty. If we continue to abide by that kind of thinking, we will never be able to develop a successful carbon-cutting plan.