Welfare Gains under Tradable CO2 Permits

Introduction It is easy to understand the opposition to liberalized trade in established markets: Domestic producers loose from increased foreign competition. It is harder to understand the opposition to creating markets, including international markets, where they currently do not exist. Many economists and policymakers have proposed establishing tradable carbon permits to decrease the cost of reducing global carbon emissions. Since there currently are no enforceable ceilings on emissions, the right to emit carbon has no market value. Emissions permits are not commodities. The usual forces that oppose market liberalization are obviously not present in this (proposed) market. Environmentalists, who favor reducing carbon emissions, frequently oppose international trade in emissions permits. It is puzzling that the group most in favor of a proposed change (reductions in emissions) is also the most opposed to a method of achieving that change cheaply (via trade). There may be a rational basis for this opposition. The theory of the second best alerts us to the possibility that in a world with distortions, opening a new market may lower welfare. If there is a plausible second-best argument against trade in carbon permits, we have not found it. There is probably an emotional basis for environmentalists' opposition to tradable permits. The environmental problems we face are related to growth, which is related to the existence of liberal markets. A misunderstanding of the relation between markets and pollution may lead some environmentalists to incorrectly equate environmental deterioration with market liberalization of any kind. Certainly there is a deep skepticism amongst environmentalists regarding the merits of markets. Economists advance the usual abstract arguments in favor of markets to explain why internationally tradable permits would be helpful in achieving reduced carbon emissions. These 3 arguments are probably correct, but they are not convincing to people who are ill-disposed towards markets in general. Economists' involvement in the debate over tradable permits differs from their involvement in previous debates over trade liberalization, e.g. during the Uruguay Round of the GATT negotiations. In both cases, the fundamental argument for market liberalization is theoretical. However, during previous trade negotiations, these theoretical arguments were backed by many empirical studies. Those studies attempted to measure, either econometrically or by means of simulation, the trade and welfare effects of various forms of liberalization. The validity of these empirical results is always debatable, but their concreteness sometimes makes them persuasive. Although trade in carbon permits is potentially important, …