Europe's Cap-and-Trade Lesson for California

Recent reports on the current status of the EU’s cap-and-trade program should instill concern rather than confidence amongst Americans.

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Joseph Mason is the Moyse/LBA Chair of Banking at the Ourso School of Business at Louisiana State University and a senior fellow at the Wharton School of the University of Pennsylvania.

In October of last year, a unanimous vote by the Golden State’s “Air Resources Board” gave California the nation’s first ever state-administered cap-and-trade program. According to the Los Angeles Times, the board’s plan—slated to go into effect this year—was inspired by European Union’s Emission Trading Scheme.

The California program’s European roots may be an inspiration to some here in the states. But in light of recent reports regarding the current status of the EU’s cap-and-trade program, such connections should instill concern rather than confidence amongst many Americans.

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The EU’s carbon market, as the Financial Times put it last week, “is in turmoil.” In what was widely regarded as an act of desperation, the EU recently moved forward on a plan to charge foreign airlines to pay for the pollution generated by landing their planes in European airports. Though the EU claims the charge is meant to protect the environment, few are buying the story and instead believe Brussels is frantically seeking new revenue streams as their cap-and-trade program continues to flounder. Next week, representatives of over 20 nations will meet in Moscow to discuss how best to handle the situation.

Suffice to say, it could get ugly.

As will be the case with California’s system, Europe’s scheme effectively sets a limit (aka a “cap”) on the amount of carbon dioxide companies are allowed to emit and then requires them to pay for any emissions that surpass that threshold. Companies that produce fewer emissions than allotted are allowed to sell their surplus emissions to companies who exceeded the limit.

Yet, as the global recession has deepened, special interests and industry lobbies have pressured European lawmakers into giving companies their emission credits for free. These favors have been handed out more or less arbitrarily and have saturated the market, predictably dragging down the price of carbon permits and largely eliminating incentive for companies to cut emissions or invest in clean air technology. And these are only a few of the problems that have plagued the European system, which even EU president Martin Lidegaard recently admitted is “not sustainable in the long run.”

If only all European imports were as flawless as pizza and the Beatles.

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Lessons from Europe, however, aren’t necessary for those who understand the basic flaws of cap-and-trade proposals for mitigating greenhouse gas emissions. First, such plans cost jobs, as restrictions on carbon emissions discourage affected companies from growing their business. Cap-and-trade will encourage companies to cut productivity, shut down altogether, or simply leave California in search of greener pastures, which, in this sense, await them anywhere else in America without having to cross sovereign borders. While working to improve the environment is important, it can only be achieved separate from political influence and has to be managed in order to reduce harm to economies already reeling from the credit crisis aftermath.

As I detailed in a 2009 analysis, prices for carbon permits will probably suffer from extreme volatility at home, just as they have in Europe. Tough economic times or general political finagling will lead California lawmakers to hand our free carbon credits to struggling companies—at least to those who are politically connected or located in swing voting districts.

In response to these concerns, many have proposed different forms of regulation for the California carbon market, but to believe state lawmakers will resist the temptation to tamper would be naïve, and political pressures to do so will be forever present, regardless of the recession’s staying power. In the end, business will be stifled, jobs and potential for the creation of new jobs will be lost, and little to nothing will be done to meaningfully improve our environment.

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Americans understood all this in 2009 when federal lawmakers pushed for a national cap-and-trade system on Capitol Hill. As a result, the idea never took off. But when California’s climate change bill—the Global Warming Solutions Act of 2006—was challenged by Proposition 23 on the November 2010 ballot, Golden State voters overwhelmingly decided to stay the course.

Maybe, with the impending failure of the plan that inspired their own model now staring them directly in the face from across the Atlantic, Californians will finally take a moment to reconsider. If their true goal is, in fact, to save the environment, they have little choice.

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