Climate change policy myopia: the ETS agreement

By Andy Reisinger 29/09/2009

This is a re-post of an article that appeared in the Dominion Post on 18 September, co-authored with Ralph Chapman, Judy Lawrence and Jonathan Boston.  —

The deal between National and the Maori party over the emission trading scheme raises serious questions about strategic policy making in New Zealand. The agreement has positive features — a price on carbon will apply from mid-2010 in some sectors — but it raises major concerns about the capacity of our democratic institutions to serve the common good of New Zealand and avoid capture by vested interests.

The deal rests on four myths about climate change policy.

Myth 1: Doing the minimum is good enough

Is doing the minimum still credible? It might have been pragmatic while climate science was being clarified in the 1990s, and then with the US refusing to join Kyoto, but it is now clear that urgent action to cut emissions is needed, globally and nationally. The new law committing the UK to cut emissions by 34% by 2020 is one example of international responses.

The delayed entry of agriculture from 2015, and snails-pace (1% per year) adjustment path for other industries are too slow to be credible when our domestic policies are exposed in international negotiations. Other developed countries are moving towards emission cuts of 80% by 2050.  New Zealand farming and other sectors cannot afford to defer adjustment to a changing world. Our businesses are innovative; they need a chance to apply their skills within the changing world order. Sheltering them from the inevitable will increase costs in the long run and foreclose business opportunities. This is the clearest lesson from the economic restructuring of the 1980s. Minimising the exposure of businesses to the price of carbon is just poor economics.

Myth 2:            We mustn’t get out ahead, especially ahead of Australia

PM John Key has commented that ’It’s not my government’s approach for New Zealand to be way out ahead of other countries.’ There’s no chance of being ahead of Europe’s 2005 ETS and countries such as Finland, Norway and the Netherlands, which introduced carbon taxes in the early 1990s, or British Columbia which did the same in 2008. But isn’t our ETS different? Well, no. The introduction of a fixed price cap in New Zealand ($25 per tonne) makes the ETS effectively a tax.

Ironically, delaying our efforts to enable a link with the Australian scheme (not yet enacted) could damage New Zealand. An ETS works best if we can trade with bigger partners, such as the EU and the emerging US emissions trading market. In addition, by opting for an intensity-based allocation scheme aligned with the Australians we rule ourselves out of trading with not only Europe but probably also the US.

New Zealand should include the agricultural sector in the ETS as soon as possible to incentivise innovation, improve efficiency, and encourage agricultural gas-reducing technologies and processes that can then earn export dollars and ensure New Zealand’s leading role in supplying high-value markets with its own distinctive brand. New Zealand cannot afford not to be ‘out ahead’ in the sectors that shape its unique economic and international trading position.

Myth 3:            Households should and can be protected from price rises

The debate on the costs of the ETS has been woefully misleading, with exaggerated claims of direct impacts, and a failure to analyse indirect impacts, and the policy adjustments other countries are making. The focus in the agreement is on short-term direct impacts on households. Yet, when emitters are shielded from paying for their emissions, the costs fall on the taxpayer, so households still pay indirectly but in a manner that is less fair.

New Zealand has a legally binding Kyoto Protocol commitment and will likely have similar post-2012 commitments. The question is how the costs of these commitments are shared and minimised. The deal means households will pay most through higher taxes than otherwise, with no incentive to contribute to emission reductions and support innovative businesses. Placing the costs largely on taxpaying households is both inefficient and represents a significant wealth transfer to companies and their shareholders, some of whom are foreign.

Myth 4: Market principles are being adhered to

Business sector disapproval defeated the 2005 carbon tax proposal in favour of a trading scheme, yet the ETS with a price cap acts like a tax. Moreover, why should market-responsive business people prefer market signals to be muted? The international carbon price is currently about NZ$30 per tonne: why should that signal be capped? If interest rates were capped, the price signal they send would be undesirably distorted. The carbon price signal proposed is to be further weakened by the ‘2 for 1’ deal, cutting the market signal to $12.50 and halving the efficiency of the market response (and leaving the taxpayer to pay for the rest). Again, this is poor public policy.

The most egregious aspect of the agreement is the intensity-based allocation arrangement that some companies demanded. This allows emitters to increase their emissions at no cost as long as emissions per tonne of product are below the industry average. In conjunction with the slow phase-out of free credit allocations, this dramatically weakens the signal to cut emissions.

Other aspects of the agreement are problematic, such as the fuel subsidy to the fishing industry: this is sheer political horse trading. But the four myths above are the main concern, and create two problems. First, they have resulted in a low-quality public policy agreement. This may reflect the poor quality of independent climate policy analysis in this country. Second, we now have a policy hotch-potch at a time when a strategic vision in support of urgent action is needed.

Critically the deal is intensely myopic, creating escalating future costs by deferring inevitable adjustment. A far-sighted and enduring policy is required, based on a broad consensus, that benefits both the economy and the environment. The National/Maori deal is not durable as it is out of line with New Zealand’s long-term strategic needs and interests.