IPA responds: Property rights and the ETS

Emissions trading is not a 'free market' solution built on private property but a 'market-based' technocrats solution, the IPA contends.

Emissions trading schemes are a regulatory imposition to achieve reductions in greenhouse gas emissions, not a free market solution built on private property.

In Wednesday’s Climate Spectator Tristan Edis suggested I helped clarify his thinking about the merits of an emissions trading scheme over a carbon tax:

“On ABC television he [Tim Wilson] said he concurred with Abbott that an emissions trading scheme wasn’t a real market. According to Wilson, it’s just a regulatory impost dressed up in drag to look like a market.”

The statement certainly reflects my sentiment; but more on that below. Mr Edis went on to write:

“The IPA is a champion of the concept of property rights … [and] thinks development of these property rights was a fantastic thing.  But they seem to forget it involved government regulating ownership of land, instead of just allowing a free-for-all.”

He is certainly right that my bedfellows at the IPA, and I, believe private property rights are a wonderful thing.

But before columnists attack critics of emissions trading for abandoning their free market principles, they should understand what free market principles are, and how they apply to ETS.

Without wanting to give a long economics history lesson, physical private property can be owned and traded without government.

Before government recognised modern property titles, people owned property. It was just through customs where others recognised each other’s territory, someone literally squatted on it, or someone just had the biggest stick and could beat others away.

Peruvian development economist Hernando de Soto’s The Mystery of Capital provides a quality discussion on the nature of property rights when formal title systems do not exist.

The role of government is to make transactions easier by creating clear and tradable titles, not the creation of property.

Emissions trading is not equivalent. Emissions trading schemes establish a regulated tradable title to emit into the commons.

If we are going to be all pure about it, the free market solution to addressing the tragedy of the contemporary atmosphere commons is not to establish emissions trading; it is to privatise the atmosphere. That isn't realistic or achievable.

In response, advocates for cutting emissions have looked at what was achieved in the sulphur dioxide trading scheme where permits are allocated and progressively decreased.

But the lessons learned from sulphur dioxide trading cannot be simplistically translated to greenhouse gas emissions. The externality of sulphur dioxide (acid rain) occurred close to the source of emissions.

The ‘global’ in global warming suggests that isn't the same in this case. That’s why only an international regime to mitigate emissions will be effective. That doesn't exist, and is unlikely to any time soon.

More importantly, emissions trading is not a free market solution. It is a technocrats solution. In their efforts to dress up carbon cutting regulation in the language of free markets, advocates for emissions trading have conveniently confused ‘free markets’ and ‘market-based’. They are not the same thing.

The term ‘market-based’ merely means something is traded, and in the case of the ETS it is an emissions permit. A ‘free market’ is a market with light, or no, regulation. They are entirely different concepts. In a free market, emissions permits are unlikely to exist.

Unlike traditional (or even intellectual) property, emissions permits only exist because government created them, even though they can be traded.

Before anyone screams that intellectual property acts like emissions permits and does not exist without government, I shall clarify that is not correct. Natural intellectual property exists – it is called a secret. Whether policy should trade the veil of secrecy for an exclusive right, and on what terms, is another article entirely. But carbon permits and intellectual property are not comparable.

Without the government there is no viable market for regulating greenhouse gas emissions through permits, as evidenced by the collapse of the now defunct voluntary Chicago Climate Exchange.

To be fair, there is a free market for carbon dioxide, it even has a price. The free market price for carbon dioxide is about $6 - $10 per kilogram ($6,000 - $10,000 per tonne) and can be purchased at your local service station (price may increase if you don’t have a refillable cylinder).

In an emissions trading scheme the government creates a market and sets the volume of permits (supply) and those that have to purchase them (demand). Without the government doing so, people are highly unlikely to buy them. A floating price carbon tax is essentially just the financial reflection of government-imposed climate regulation.

And that market is then heavily influenced by how the government changes the supply or demand, including being influenced by political considerations. The gaping, structural flaw of emissions trading is that to be effective to drive investment the permit has to be very high (arguably in the hundreds of dollars) with certainty and predictability it will stay there for a long period of time. But because the supply and demand of permits is always open to political considerations that confidence struggles to exist, despite the best efforts to achieve it through 'independent' authorities.

The only relevant matter for free marketeers in defending the property rights of emissions permits is that if the government establishes them, requires them to be purchased, and then they are significantly devalued by government action, there should be compensation to owners. Sadly, protection of private property in the Australian Constitution makes compensation unlikely should a government do so.

In that context, emissions trading and Direct Action are different sides of the same regulatory coin. Both are undesirable solutions. On that basis the criteria to assess the relative merits of each is long and would require another article. For example, emissions trading schemes are arguably more efficient, but ‘Direct Action’ is more proportionate to comparable action in other countries.

The free market solution to cutting emissions is innovation of low-carbon technologies that can stand on their own two feet. Necessity is the mother of invention and there is already global demand for abundant, cheap, renewable energy that doesn't require fossil fuels. The problem is that despite the cost of extraction, fossil fuels remain competitive. The challenge is how to bridge the gap.

For many that gap should be met by taxing existing technologies out of competitiveness through emissions trading to spur innovation. But I'm in rare agreement with Kevin Rudd's former chief economic adviser, Alistair Jordan, who argued in an essay:

"Unfortunately, both the political rhetoric and the conventional wisdom are wrong. Emissions trading schemes will find the most efficient way to reduce emissions from existing technology (his emphasis), but they are not particularly effective in bringing forward the technologies of the future."

It's illogical to use taxes and regulation to deploy technology that is nowhere near standing on its own two feet.

The most important factor to ensure success in innovation is keeping markets open so capital continues to flow and investors have the confidence to put their money down for worthy projects. Similarly, barriers for free trade for low-carbon technologies should also be opposed. That’s why I’ve aggressively defended open markets and the importance of intellectual property rights for low-carbon technologies in the past as the best solution to cut emissions.

Innovation is the best, free market way that uses property rights to drive sustainable economic and environmental change, not trying to tax uncompetitive technology into competitiveness.

Tim Wilson is Director of Climate Change Policy at the Institute of Public Affairs.