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Cap and Trade Economics

Getting At The Elemental In Another System We Started, Then Abandoned

By Paul Smart

Not that long ago, “cap and trade” was seen as an across-the-board success story for reining in man’s penchant for pollution. After first becoming law in 1990, as a Bush-era invention under the name “emissions trading,” the idea was noteworthy as much for its odd birth from discussions (and arguments) between environmentalists and libertarians as its resulting businessman’s approach to tempering the corporate world’s worst practices.

        Now standardized throughout much of the world, including a Chinese roll out that started last year, “cap and trade” has moved beyond ethical questions, and even this nation’s resurgent reluctance to admit climate change science, to become a key global example of the ways in which bartering economics can be utilized to address difficult issues.

        It all started with a series of problems. Smog was a term for the “smoky fog” that started descending on crowded cities in the early 20th century, and was getting pegged as a killer during key events charted in London, Los Angeles and New York from the 1940s into the 1960s. Which led to scientific studies, followed by growing awareness, about air pollution being as measurable as what one can see in water, or by the side of a road. Which in turn led to the “Acid Rain” phenomenon, wherein the movement of air pollution between disparate states and nations became a major cause—and later awareness of general warming trends and their effects on the entire globe.

        Cap-and-trade, as the system was first known, came about as the result of micro-economic computer simulation studies by the National Air Pollution Control Administration (the EPA’s predecessor) that used mathematical models of several cities and their emission sources in order to compare the cost and effectiveness of various control strategies. Abatement goals were arrived at, along with systems of “trading strategies” to reach a “least cost solution,” which resulted in the Acid Rain Reduction legislation of 1990, whose “emission trading” standard was then adapted as a global system at the 1992 UN Framework Convention on Climate Change (UNFCCC) in Rio.

        By 1995, the idea of getting businesses to regulate their own emissions on a bartering basis, calibrated against an agreed-upon level of desired global emissions, was found to have successfully lessened the Acid Rain phenomenon. By 1997, cap-and-trade was one of the key elements behind the Kyoto Protocol to next attack the worldwide rise of greenhouse gases and their effects on everything from shifting weather patterns to ice cap melt and the potential for dramatically rising oceans.

        Successful exchanges were set up on an international level with actual trading exchanges, similar to stock and commodity markets, in Europe, on the NASDAQ commodities’ market, and in Chicago (although their Climate Exchange ended up closing in 2010). The idea had two levels: between nations, and among individual businesses. “Caps” were set on what levels should be reached, carbon-wise, to avoid the worsening effects from greenhouse gas effects. Measurement was in tons of emissions. Those emitting more pollution could trade credits with companies or countries with little or no pollution. Price levels shifted based on the cost of mitigating pollution as demand, and how much supply non-polluters could supply in credits.

The result was that within a decade, trading in emission permits became one of the fastest-growing segments in financial services on a global basis, with market estimates in the billions for Europe alone. Predictions started being made that carbon would become the world’s biggest commodity market, and probably the world’s biggest market overall, until water scarcity began trading.

        But then another result arose: like the wave of affordable insurance plans that started emerging from Massachusetts a decade ago, the origins of cap-and-trade were overlooked as a growing number of businesses, and then politicians, started looking for ways of getting away from the idea of pollution caps altogether by retaining the voluntary market idea behind the system and rejecting any need for a carrot. In other words, Acid Rain was one thing but the larger issues behind climate change something else altogether. It seemed cheaper, for some, to simply refute the need for a cap rather than trade anything, even on a voluntary basis.

        The result has been the United States’s withdrawal from the concept they originally came up with, excepting for some regional agreements and markets, in what are essentially Democratic strongholds in the Northeast, along the West Coast, and around the Chicago area. And apart from a continuing international market in emissions trading that keeps growing despite populist bickering against the idea.

        In the final rounds, cap-and-trade has become the world’s strongest example of a market-based bartering system devised to date, beyond the very idea of money itself. And yet, with its involvement in such a voluble and ultimately nasty trading base as pollution, many also see it all as a perfect embodiment of the Hobbes vs. Locke, good versus innately bad philosophic arguments that are now riling our politics—and possibly, eventually, our most elemental economics, as well.