The Problem With Internationally Tradable Emission Permits for Greenhouse Gas Abatement

The next major round of international negotiations on controlling global climate change is to be held later this year in Kyoto. The focus of talks to date has been on policies to reduce worldwide carbon dioxide emissions to 1990 levels and hold them there. A proposal by the United States would achieve this by creating a system of internationally tradable emissions permits. Although the U.S. proposal has attractive features and has been endorsed by a number of prominent economists, it has several serious flaws that would prevent the treaty from being ratified and implemented. First, it focuses exclusively on stabilizing emissions even though a much stronger case can be made for reducing the growth of emissions rather than allowing no growth at all. A second problem is that it would also be very difficult and expensive to monitor and enforce. Third, it would generate such huge transfers of wealth between countries that those generating most of the world's emissions would be unlikely to ratify the treaty. More important, these wealth transfers could cause dramatic changes in exchange rates, trade balances, and international capital flows and would put enormous stress on the world trading system. A better alternative would be to set up a system of national permits and emissions fees. Each country would be allowed to distribute tradable emissions permits equal to its 1990 emissions. Each government would also agree to sell additional permits at a fee specified in the treaty, say U.S.$10 a ton of carbon emitted. The effect of the policy would be to encourage firms to reduce emissions whenever they could do so at a cost of $10 a ton or less. Since this alternative does not focus on stabilization and instead aims at the more modest goal of reducing emissions where it can be done at low cost, and it includes an allowance for 1990 emissions, it is far more likely to be ratified and implemented. It would give firms an incentive to reduce emissions without causing huge international transfers of wealth and would avoid causing havoc in the system of world trade. Because the fee would be uniform throughout the world, the emissions reductions would be accomplished at minimum cost. Finally, the revenue raised by emissions fees would provide an incentive for individual governments to enforce the policy.