Misdirected Innovation: Environmentalist Taylor on Cap-and-Trade (Part I)

[Editor Note: This is Part One in a two-part series by Mr. Tanton on counter-productive regulation passed in the name of addressing manmade climate change. Part II tomorrow focuses on California. ]

Cap-and-trade programs (CTP) do not provide incentives to develop innovative technologies and likely increase emissions, according to a new essay, Innovation Under Cap-and-Trade Programs, published in Proceedings of the National Academy of Sciences. Author Margaret Taylor, a researcher at Lawrence Berkeley National Laboratory, completed her study as assistant professor at the University of California-Berkeley’s Goldman School of Public Policy.

Based on actual case studies, she found that CTP have reduced incentives for research and development. “Policymakers rarely see with perfect foresight what the appropriate emissions targets are to protect the public health and environment,” said Taylor.

Emission targets might actually be set more strict, she explains, even while the mechanism (i.e. CTP) may be inefficient, or ineffective, or counterproductive. Yet policymakers also seldom set targets they don’t have evidence that industry can meet. This is where R&D that can lead to the development of innovative technologies over the longer term is essential.

The Estimation Problem

Putting aside whether the targets (i.e. emission levels) are set correctly, the question remains whether cap-and-trade is a useful mechanism. In fact, it might actually get in the way of the technology that reduces emissions and achieves other worthwhile goals like productivity enhancement and wealth creation.

Taylor’s research found that pre-implementation, analysts overestimated the value of emissions reductions in order to achieve targets. This was seen in overestimates of the value (price) of allowances, which are permits to release a certain volume of emissions under a CTP. If an entity can reduce emissions cheaper than the market price of allowance, they can either sell these allowances in the market or they can bank them to meet later requirements.

The programs Taylor studied exhibited lower-than-expected allowance prices, in part because program participants adopted a wider range of techniques for reducing emissions sources before trading started. A large bank of allowances grew in response signaling that allowance prices would remain relaxed for many years. The lower-than-expected price signal did cause emissions sources to reassess their clean technology investments, however, and led to significant cancellations of research and development projects, Taylor reported.

Meanwhile, the low prices also signaled to researchers who continued to develop clean technologies – which are often distinct from the emissions sources that hold or are required-to-purchase allowances – that potential returns to their research and development programs, which always have uncertain and longer-term payoffs, would be lower than expected, or at least more risky.

This helps explain Taylor’s finding that patenting activity (the dominant indicator of commercially-oriented research and development) peaked before CTPs were passed and then dropped once allowance markets began operating, reaching low levels not seen since national SO₂and NOx regulation began in 1970.

The correlation of cap-and-trade to drop off in R&D and patenting activity cannot be ignored.

Remember James Hansen on Waxman-Markey?

In early 2010, MasterResource posted on the Left’s civil war over cap and trade. Rob Bradley quoted climate activist James Hansen, who worried that parties (but not his faves) would unfairly profit from the necessarily complex cap-and-trade program designs. Hansen wrote:

The public is largely unaware of a momentous battle about to be fought in Washington. The stakes are enormous. Yet the public has not been well informed.

Ignorance of the matter derives in part from the fact that the conflict was initiated via the highly charged issue of climate change. Climate is complex. People have different opinions about the extent to which humans are causing climate change. Fundamental belief systems are involved and discussion can be emotional….

Yet Washington appears intent on choosing a path defined by corporate greed. Unless the public gets engaged, the present Administration may jam down the public’s throat just such an approach, which, it can be shown, is not a solution at all.

Natural Progress

Missing from Dr. Hansen’s perspective is that just maybe the energy system is getting cleaner on its own, and in addition to its other problems, cap-and-trade would SLOW progress, not speed it up.

This is all true whether we’re talking about a ‘pure’ cap and trade or its many progeny: cap-and-dividend, fee-and-dividend, etc. That is the profound finding of Taylor’s study.

From 2000 to 2010, indeed, the carbon dioxide intensity of the U.S. economy—measured as metric tons carbon dioxide equivalent (MTCO2e) emitted per million dollars of gross domestic product (GDP) — improved by over 17 percent, or 1.7 percent per year.

The decrease in U.S. CO2 emissions in 2009 resulted primarily from three factors: an economy in recession, a particularly hard-hit energy-intensive industries sector, and a large drop in the price of natural gas that caused fuel switching away from coal to natural gas. The latter, which further lowered our emissions intensity, was the direct result of technology advancements, such as hydro-fracturing of shale, called ‘fracking.’ Improvements occurred even in years of economic growth, not just recession.

While we (too) often hear that the U.S. is responsible for 20 percent of global emissions with only 5 percent of the world’s population, we seldom hear that we’re responsible for 28 percent of global GDP. We achieve such production at low emissions because our productivity and emissions intensity (related but not perfect analogues) are comparatively so good.