Economist warns against false market of CO2 controls

Published January 1, 2002

Attempting to make CO2 controls more palatable to the American public and advocates of the country’s free-market economy, some policy wonks are suggesting a “market-oriented” approach to eliminating so-called greenhouse gas emissions. A recent study, however, suggests such approaches create only false markets that are not much better than command-and-control anti-CO2 schemes.

In “What’s Wrong With Regulating Carbon Dioxide Emissions?” Canadian economics professor Ross McKitrick examined various proposals for limiting carbon dioxide emissions. The study formed the basis of a briefing, sponsored by the Competitive Enterprise Institute’s Cooler Heads Coalition, that McKitrick conducted for Congress.

Among the most common approaches to controlling CO2 emissions, McKitrick lists:

  • command-and-control;
  • voluntary measures;
  • tradable quotas given to existing emitters;
  • tradable permits sold at auction; and
  • CO2 tax.

Each approach has its flaws, according to McKitrick–and some are more flawed than others.


Command-and-control, according to McKitrick, defines any system that relies on central planning. Most commonly, bureaucrats and politicians decide on targets (the command part) and then set up measures to enforce compliance (the control part).

Command-and-control is the most common form of environmental policy, but McKitrick notes it is fraught with problems.

“Principally, central planners can never get enough information to figure out the least-cost way to achieve a target,” he explained. “In the case of CO2 there are so many millions of emission points, and the costs of abatement at each point can be radically different than at other points, so any attempt at centralized micro-management of emissions will end up being excessively costly. No matter what emissions reduction is eventually achieved, it could have been done much more cheaply with one of the other methods.”

Theoretically, command-and-control systems can ensure compliance with preset goals, but unnecessarily high costs and inefficiencies are inevitable. To attempt to reduce CO2 emissions with command-and-control measures would be highly inefficient and punitive to the American economy, McKitrick concludes.

Voluntary measures

Voluntary measures, argues McKitrick, are also doomed: either to be ineffective, or to serve as an excuse to subsidize favored industries or companies. Voluntary measures are “an attempt to seem concerned about a problem without actually addressing it,” resulting in “confusing symbolic gestures.” Either emissions need to be cut, or they don’t need to be cut.

Emission goals adopted voluntarily will never be met, McKitrick said, without subsidies to encourage adherence to the goals or enforcement measures to punish divergence. Either approach emasculates the voluntary nature of the system.

Cap and trade

One method of CO2 reduction often advertised as market-friendly is a cap-and-trade system.

Under such a system, the right to emit predetermined amounts of carbon dioxide would be given away, with the largest current emitters generally receiving the majority of future CO2 emission rights. Permit holders would then be allowed to sell or trade their emission rights. In theory, such a system works for firms that can easily cut emissions, as well as for those that cannot.

While such cap-and-trade measures are preferable to command-and-control, McKitrick observes even cap-and-trade is flawed. The artificial scarcity of CO2 emission rights creates a “windfall” beneficiary in whomever is lucky enough to garner the initial emission rights.

For example, in one of the most noteworthy developments of the Marrakech climate talks in early November, Russia gained the right to double its carbon sequestration credits, giving the nation a vast amount of unused emissions to sell. As a result, Russia now stands to receive substantial economic benefits from tight controls on CO2 emissions . . . and therefore has an incentive to fight a loosening of emission standards even if science shows tight controls are unnecessary.

A similarly skewed market for CO2 emission rights would also occur domestically. Even if science ultimately demonstrates that tight CO2 standards are unnecessary, companies that have invested great sums in CO2 emission rights will fight any attempt to loosen the standards. Otherwise, they will have purchased a valuable commodity that stands to become worthless.

That incentive structure is already at work. Although energy-industry firms would seem to have the most to lose from tight CO2 emission controls, many have supported CO2 restrictions. Why? Because they have already spent significant sums of money on CO2 reduction, in anticipation of mandated cuts in the near future. Their voluntary CO2 cuts today may be worth a great deal of money in the future, regardless of whether sound science deems such cuts necessary.

A further flaw in the cap-and-trade system, according to McKitrick, is that the initial beneficiaries pay nothing for what are presumably valuable emission rights. Those beneficiaries–a select group of corporations or other private entities handpicked by the government–then reap all the benefits from the sale of rights they paid nothing for themselves.

McKitrick argues that “society itself, represented by the citizens’ government,” should be the initial owners of the emission rights. Emitters, then, would pay society–i.e., the government–to purchase the emission rights they need.

Auctioned permits

An auctioned permit system is similar to cap-and-trade, except that the initial distribution of emission permits would go to the highest bidder (respecting the permits’ initial fair market value), rather than to an arbitrarily selected group of private entities.

According to McKitrick, a system of auctioned permits would initially facilitate economic efficiency and distribute the economic benefits more justly: to society itself, rather than to a government-selected group of private entities.

Even so, the auctioned permit system is flawed. Government still sets the level of permitted emissions, thus creating scarcity and artificially valuing the emission rights. That means the incentive structure will be skewed, as it is under the cap-and-trade system. If science demonstrates tight CO2 controls are unnecessary, those who have purchased emission rights will nevertheless have an incentive to fight a loosening of the standards, to the detriment of society at large.

Under both an auctioned permit system and a cap-and-trade system, there will be initial uncertainty regarding the proper amount of CO2 emissions to permit. While any market uncertainties are harmful, miscalculations regarding the amount of emissions to allow are especially harmful.

Explains McKitrick, “Economists have looked at this problem of uncertainty, and have shown that in the case where the demand curve for permits is relatively steep, but the damages due to emissions accumulate relatively slowly [both of which hold true for CO2], the costs of mistakes associated with picking quantities are much higher than those associated with picking prices.”

CO2 tax

Because it’s better to make a mistake picking prices than picking quantities, McKitrick argues that a CO2 tax would be less burdensome than an auctioned permit system. The latter involves initial uncertainties about the proper amount of CO2 to permit; the former involves initial uncertainties about the proper price to place on a unit of CO2 emission.

But significant problems remain even in this marginally better system, admits McKitrick.

While one can accept the inevitability of initial uncertainties regarding the proper price for a unit of CO2 emission, it’s more difficult to accept that a CO2 tax would be unlikely ever to reflect proper pricing.

Why? McKitrick explains that the marginal social cost of emission reductions using a CO2 tax would likely begin at about $25 per ton . . . but the marginal social costs of the emissions themselves are likely to be at or below $5 per ton. In other words, “the costs of emission reductions will exceed the benefits for any target, however small.” Accordingly, the optimal carbon tax is zero–which defeats the purpose of a carbon tax.

Where does this leave us?

The McKitrick analysis offers valuable insight into the problems with CO2 controls, be they cloaked in “market-oriented” terms or not. Certainly, free-market environmentalists may dispute whether an auctioned permit system is inferior to a “properly priced” CO2 tax system (if such proper pricing were possible). But the point is moot, in that the McKitrick study itself acknowledges it is impossible to fix a proper tax on CO2 emissions when the harms of the tax outweigh the benefits of CO2 reduction.

So where does this leave us? Is there a possible solution? Yes, concludes McKitrick: Let’s take our time and gather all the scientific evidence before we rush into controlling CO2 by any method.

“What is the rush?” asks McKitrick. “Time is not pressing. This is a complicated issue. Let the scientific work proceed.”

The science as we know it today supports McKitrick’s approach. Since 1979, satellites have been precisely measuring the temperature of the lower atmosphere across the entire planet. In those 22 years, the Earth has not warmed at all. Not a single degree. Not even a tenth of a degree. Why rush to impose costly carbon controls when global warming theory is just that–an unproven theory.

For more information . . .

The full text of Ross McKitrick’s October 11 briefing, “What’s Wrong With Regulating Carbon Dioxide Emissions?” can be found on the Competitive Enterprise Institute’s Web site at,02191.cfm.