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Now that NZ has amended the Emissions Trading Scheme legislation, ahead of the Copenhagen Meeting, I thought I’d try to make some sense of what all the fuss is about. This may be of limited value because I’m no expert myself.

Question 1: What’s Going On In The Atmosphere?

The simple answer is that we’ve front-loaded the carbon cycle. Lots of carbon it turns out, was stored as coal, natural gas and oil. And lots of carbon used to be stored as trees in tropical rainforests. So what we’ve done is abruptly release lots of that stored carbon (and associated gases) into the atmosphere.

Question 2: What’s going to happen?

There seems to be pretty wide agreement that we’re going to overshoot historical CO2 saturations (considered benign for human life). There is some uncertainty over what this means. But a lot of the projections are enough to make a lot of people, really, really nervous. It’s hard to see that this overshoot will be a good thing.

Question 3: What’s all the talk about Kyoto mean?

In the Kyoto meeting, various developed countries agreed to try to base their GHG emissions on 1990 levels. For NZ, this agreement had a few of fish-hooks.

First, it treated the release of stored carbon (from coal or oil or tropical rainforests) as the same problem as current carbon cycles from agriculture. So growing food as treated as a ‘bad’ in the same way as a roadtrip from LA to Las Vegas to visit the strip clubs is a ‘bad’.

Second, within agriculture, subsidised systems like Europe were treated on par with NZ unsubsidised systems. So our starting point was yeah, it’s okay if the EU wants to pay its farmers to exacerbate the emissions problem. This is also what is called putting ourselves at a competitive disadvantage. Or just a plain dumb move.

Third, the forestry fish-hook. If trees get chopped down in NZ to generate building materials, all the carbon in those trees is assumed to be released when they’re chopped down. Of course, it’s actually really locked up as furniture or floor boards. But this is a neat accounting trick to inflate our GHG emissions.

Question 4: So Why Did We Ratify Kyoto?

We assumed we’d be winners. In the early 1990s, people were planting trees like crazy in NZ. The reason was US federal law had just closed down most of the Pacific NW old growth forests. This was to protect spotted owls. So with a big fall in US timber exports, demand for NZ logs soared. Increases in forest areas meant we thought we’d be a winner.

Question 5: Why did everyone else sign Kyoto?

Everybody who signed Kyoto got all the credibility and warm glow for looking like they were doing something. But Kyoto didn’t mandate any action. So Kyoto frontloaded the political benefits to the signees, and backload all the adjustments costs on to Governments 10+ years down the track. Easy political win for the politicians of the time. What effect did Al Gore have on US emissions while he was VP?

Question 6: Why have we become losers in the GHG global game?

People in NZ stopped planting forests. They hit a hiccup in the 1997 Asian crisis. But this got worse from 2000 onwards. The combination of a high exchange rate and high interest rates killed off planting rates. Land-owners converted forests to dairy farms. And the government increased uncertainty for forestry investors by picking several fights with the sector. We actually ran into a deforestation problem.

Question 7: Why have the ETS?

The Emissions Trading Scheme is NZ’s device to lower our GHG emissions. The reality is that the only way GHG emissions can come down, is if households decide they’re okay with being made worse off. So the policy problem is finding a way that makes people worse off- that they’ll agree to.

We actually have to take a bigger hit on our costs to make a difference. The global energy subsidy is about $US 300bn a year. This is a device many countries to pay their citizens to use fossil fuels. So unsubsidised countries have to take a hit of say, over $US 300 bn a year on our energy costs before we can start making a difference. The same thing applies to various countries that subsidise deforestation or subsidise inefficient agricultural systems.

So part of the GHG problem is that for years, various countries have been spending hundreds of billions of dollars on ways to make it worse. The solution is of course, if you live in an unsubsidised country, you get to pay even more costs to offset this. Great huh?

Question 8: Will the ETS work?

The problem we run into is that the global objective isn’t to reduce NZ’s emissions. The global objective is to reduce global emissions. That creates a massive, international coordination problem. If we include agriculture before anyone else, there’s a risk that less efficient (more GHG emitting pastoral economies) will get a market advantage. We have less cows, someone worse than we are has more cows. Emissions could go up.

This is the Achilles Heel of the ETS. It has to work internationally and in a way that coordinates all players. NZ doesn’t live in an isolated box.

Question 9: Aren’t we subsidising polluters?

This point shifts the argument away from outcomes to equity (and has a quaint flypaper theory of costs). If our efficient exporters lose market share because they enter an ETS before other countries, then global emissions could rise. There’s no point feeling all virtuous if we don’t get a global reduction in emissions.

The second I’m afraid, is that the polluter-pays principle is somewhat naive and quaint as theories go. Households always end up paying some of these costs- doesn’t matter if charges are put on them or polluters. You can’t immunise households from the costs of pollution reduction- it might be in terms of higher product prices, or lost income opportunities, or less national income or the like. Ever noticed that when taxes go on to beer, wine and spirits that the breweries push up product prices? Costs will get passed on. You can’t isolate households from these effects. Polluter pays is a slogan, not an economic reality.

Question 10: If I was Emperor of the World?

First, carbon taxes. Implement carbon taxes with offsetting reductions in income and profit taxes. It’s easy to understand, the incentives to use less carbon are transparent, and you can reduce the financial costs by tax offsets. And it doesn’t require the same level of international coordination. Taxing carbon is no less arbitrary than taxing people’s labour.

Second, end energy and deforestation subsidies. Seriously, why are we being asked to swallow big costs to allow other countries to happily make the problem worse?