A short primer on climate change and the greenhouse issue

The Protocol was negotiated against a background of expectation that an economic mechanism of 'carbon trading' will evolve. Basically, the idea is that the nations will issue permits for carbon emission, set to match the targets set by the Kyoto Protocol or its follow-on agreements. The permits will be tradeable, both nationally and internationally, with the idea that market forces will ultimately replace government direction in the process of encouraging more efficient use of fossil fuel. Individual companies will be able to decide whether to spend money on new 'carbon efficient' technology or on the acquisition of carbon credits from those industries or countries which have a surplus.

The economic bottom lines of a carbon trading economy are as follows.

First, it is a mechanism of imposing a cost on carbon emission as a means of encouraging efficiency in the use of fossil fuel. The rather esoteric discussion about the potential for trading between those who can sell 'carbon credits' and those who need to buy them tends to obscure the fact that the number of credits will be less than that needed for the nations to carry on business as usual. There will be a net cost to the nations, and presumably that cost will fall mainly on the energy industries.

Second, the cost is significant. One can argue about the numbers, but both quick calculation and detailed economic modelling suggest that full implementation might cost Australia something of the order of one or two percent of its gross national product a year – that is, something of the order of $6-12billion a year.

Third, the economic disturbance will create winners and losers quite apart from the energy industries themselves. For instance, it is unlikely that the costs to Australia will be spread evenly between the states.

There is considerable national and international momentum towards carbon trading in one form or another. And there is no doubt that the larger energy-related industries are already trying to position themselves to take advantage of carbon trading opportunities should they arise, and are already looking towards methods of limiting their carbon emission. This is presumably a good thing, although from the strictly rational point of view they would be foolish to spend effort on improving their carbon efficiency before such an improvement becomes mandatory. There are already examples where industry is actively delaying improvement so as to position itself for maximum benefit in the future when the rules of a carbon trading economy are established.

Is It Worth it?

Given the enormous costs associated with the development of carbon trading economies, one would have imagined that the Kyoto negotiations involved some sort of cost-benefit analysis. In fact, no such calculations were made.

We are beginning to have a rough idea of the costs. Australia for instance has earmarked close to a billion dollars over the next few years to encourage industry to become more carbon efficient. This billion dollars is relatively small compared to the one or two percent of gross national product which may be the cost to Australia of implementing a carbon trading scheme.

Because of the uncertainties associated with both the science and the possible impacts of climate change, we have absolutely no idea of the long-term benefit. For all we know, it may be a long-term loss.

One can make a few general statements.

First, it is very hard to justify the expenditure on purely economic grounds. Even if the impact of climate change is detrimental, discounting of future value argues against the expenditure of lots of present money on the problem. One might consider it cheaper to adapt to climate change than to distort the economy of energy usage.

Second, one could perhaps justify the expenditure on 'environmental-economic' grounds provided that society is convinced that it should spend today's money on preserving the current environment for the benefit of generations more than 100 years ahead.