Carbon Arbitrage

Well I'm back, time to delve into the intriguing world of arbitrage! 

Arbitrage is a financial term used to describe the exploitation of differences between markets. The example I gave last week was British Columbian drivers crossing the border to refuel their cars in an attempt to avoid a state carbon tax (Elgie and McClay, 2013). This also represents a really important hurdle in implementing carbon taxes on a global scale (Withagen and Halsema., 2013)

Scaling the issue up, unless there is strong cooperation between states, competitive taxation can lead to a similar result as observed in British Columbia. In the globalised economies we live in today, capital is extremely mobile and able to exploit advantageous taxations schemes across the globe, at the detriment to less competitive nations (Drezner, 2002). This reasoning is often used by nations to justify their opposition to a carbon tax, making such a scheme difficult to implement. Take for example the USA. 

In August 2013, the House of Representatives passed an amendment requiring 'the administration to receiveapproval from Congress before implementing a carbon tax'. From my rather basic understanding of US politics (correct me if this is wrong), this effectively translates into a blocking of any attempt by Obama to implement such as scheme. So what was the justification? This is from a press release by representative Scalise:

“President Obama’s plan to impose a tax on carbon would cause household electricity rates to skyrocket while destroying millions of American jobs. … The House sent a strong bipartisan message to President Obama that a tax on carbon would devastate our economy and he needs to drop any idea of imposing this kind of radical regulation"

If this is the case with market leaders like the USA, what about emerging economies where competitiveness is even more important to their economies. Both India and China have refuted the notion of a strict Carbon Tax (Oster, 2010): arguing that the loss competitiveness would cripple the development of their economies.

Underlying this stance on Carbon Taxation is the ‘race to the bottom principle’ (Drezner, 2002). This is the socio-economic phenomena where competition between states in an increasingly globalised world results in a trend towards increased deregulation to remain attractive.

Simply, Carbon taxation schemes come at a cost to economic competitiveness. 

Australia : a recent example of a failed Carbon Tax

Australia was one of the first non-EU countries to adopt a Carbon Pricing strategy. First proposed in 2007 and implemented in 2011, the tax was repealed in June this year. Amongst the issues created during this period, a loss of industry competitiveness was pivotal to the tax repeal (Splashand Lo, 2012). In 2013, J.P Morgan estimated that the tax had reduced the trading value of major Australian Employers BHP and Rio Tino PLC by 6% (Taylor and Hoyle, 2014), losses that translated into growing unemployment rates.

Source

The short-term  costs of carbon taxes therefore can be substantial for states that try and implement them in isolation. And ultimately it is often short-term economic changes that translate into policy, as seen in Australia.

The issue of arbitrage also limits the actual value of carbon taxes as a means to reduce emissions. Carbon leakage refers to the spill-over of emissions to countries with less strict emission regulations (IPCC, 2007). Carbon taxes may provide an effective means to reduce an individual nation’s emissions, but arbitrage simply allows this reduction to spill-over into increased emissions elsewhere.

So then Arbitrage is clearly a substantial hurdle in the way of effective carbon tax implementation. In my next post I’m going to talk about some of the approaches we can take to meet this challenge.

"I like to pay taxes. With them I buy civilization"

As much as I like a good tragedy story, I think we can all agree that they are best left to fiction. So then, let's talk about avoiding Hardin's tragedy from an emissions perspective. 

As I discussed in the previous post, the problem is pretty much caused by a shared damage and privatised profits scenario. This creates the Free Rider problem; individuals are encouraged to pollute as much as possible and take as little responsibility as possible for the shared environmental degradation (Hardin,1968). Solving this issue then requires the privatisation of the costs of environmental degradation to better reflect the environmental cost of consumption (Elkins and Baker, 2001).

How can this be done?

A Pigouvian Tax - "I like to pay taxes. With them I buy civilization"  Oliver Wendell Holmes

If you've ever studied economics at any level you will have seen this diagram, time to put it to use! A piguvian tax is essentially an attempt to incorporate the negative externalities (negative social costs) of consumption into the price of consumption itself. In this context, carbon taxes can be used to increase the cost of burning fossil fuels to reflect the environmental damage they cause. Given that demand for anything generally decreases with increasing price, the market equilibrium point where demand=supply is shifted to a lower consumption value and emissions are reduced (Q2). 

So then, what are the benefits of this approach:

Well one of the greatest advantages is that it is tried and tested. The welfare state is fundamentally built upon taxation and revenue recycling, it simply needs to be applied in an environmental context. The revenue recycling process itself is also vital. Funds are needed to subsidise less cost-effective energy sources, and promote adaptation to changing climate. Taxes can be used to not only privatise the costs of carbon emmission, and also lower the cost of cleaner energy sources (Roughgarden and Schneider, 1999).

British Columbia: a revenue-neutral carbon-tax case study -An Environmental (and Economic) Success Story (Elgie and McClay, 2013)

In 2008 BC implemented a tax which not only increased the cost of emissions, but also brought value to climate emission reduction itself. 100% of the revenue gained from taxation is returned directly to consumers through reduced income taxes. The results have so far been impressive:




Summarised, the data exhibits that Carbon Taxes can help reduce emissions, without an economic cost. 

Too good to be true?

Well I'm a sceptical person so I like to dig a little deeper when presented with information like this. An interesting criticism of the British Columbia tax is that there is evidence of arbitrage within the system. 

Take a look at this link: Tax gap has B.C.ers driving south for gas: watchdog

While this is just a small flaw in an otherwise successful system, it raises a key issue when attempting to tax carbon on a larger scale. How do you prevent cheating within an individual taxation system, and avoid taxation competition between states? These are key questions I will answer in my next blog so stay tuned! 

Secret Link

Selling Climate to Save It

Unless you've been living under a rock, I'm sure you've heard of eco-tourism; perhaps you've even been on a holiday specifically because it was classified as 'eco'.

What you may not know, is that eco-tourism is just one little part of something much, much bigger. 

Over the past few decades 'green capitalism' become prevalent at all levels of society. It emerged around the same time as neoliberal economic policy in the 1970s and 80s and was built upon the same market principles.

The key idea underlying green capitalism is that environmental degradation is a result of the undervaluation of the environment itself within traditional markets (Castree, 2010). The reasons for this can be summarized under the principles of the tragedy of the commons:

The Tragedy of the Commons:

Hardin's (1968) economic theory essentially discusses a common piece of land that can be analogous for the environment as a whole. The land is shared between members of a community for the grazing of each individual's livestock. The dilemma he proposes is that since the animals are all individually owned, the benefits reaped from grazing are reaped by individuals. However, the damage done to the common by each individual's cows are shared among the community as a whole. Since the individual benefits of grazing far outweigh the shared cost to the land, it is economically rational in the short-run for farmers to graze as much as possible. The issue: in the long run, the common becomes entirely barren and the farmers are left with nothing to feed their cattle. What makes this scenario a tragedy it occurs even when individuals are aware of what their actions will lead to in the future; there is an incentive to use the remaining resources before other individuals deplete them (Paavola, 2011). Individually rational actions, do not always produce a collectively rational outcome (Coleman, 1990)

Despite constantly being criticised for its actual applicability to real life (this seems like a pretty common thing for economic theory and Elinor Ostrom actually won a nobel prize for her critical take on the theory), an area in which is seems to apply quite nicely is climate change.

Climate Change: Climate change: the ultimate ‘tragedy of the commons’? (Paavola, 2011)

So then, how does this work. Well proponents of neo-liberal strategies argue that the atmosphere can be thought of as a common, we all need it in our carbon driven economies, but it is not individually owned by anyone. It is essentially a sink for GHG emissions resulting from consumption and production of goods. Climate change can then be thought of as an ultimate tragedy of the commons since it is in each individual’s interests to profit from exploiting the shared resource of the atmospheric carbon sink, yet the responsibility for maintaining it at a sustainable level (whatever this level may be) is a global burden.

This really falls into behavioral ideas of myopia again; as humans we tend to prioritise what is immediately in front of us over the bigger picture and more distant issues. This can specifically be thought of as selfish-actor myopia as exhibited by this quotation from Hardin himself:

‘Each man is locked into a system that compels him to increase his herd without limit--in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all’ (Hardin, 1968 p.248). 

This reminds me a bit of the opening monologue to the fellowship of the ring, I wouldn’t be surprised in Hardin took some inspiration from JRR Tolkien.

Selling Climate to Save It:

If we are therefore going to believe this idea, then the answer to climate change (as a form of environmental degradation) needs to come from a correction of this market issue.

In my next post I’m going to talk about the privatisation of the ‘commons’, focusing on exactly how a shared resource like the atmosphere can be allocated to individuals.

Secret Link for LOTR fans

Carbon Cowboys

To set the scene for my next few posts I thought I'd bring up something I came across a few years ago:



Watching this report reminds me of a book I read in my first year of University:

Changes in the Land : Indians, Colonists and the Ecology of New England  by William Cronon

(Don't judge this book by its cover, some of the stuff that happened during this era is so ridiculous it almost reads likes fiction)

John Nilsson is a figurehead of carbon trading's weaknesses. Just as Native Americans were offered coral beads in exchange for their land centuries ago, Nilsson offers exploitative contracts to indigenous Amazonian people in exchange for their (now valuable) property. To make matters worse, he has even been caught admitting to plans to fell the old forest and replace it with more profitable palm oil plantations. 

It is an extreme example, and there is even an arrest warrant signed on  Nilsson in Peru, but it exemplifies the dangers of what McAfee (1998) termed 'selling nature to save it'. 

Anyway, segway over; next carbon trading!