Although UN negotiations are now focused on individual country commitments, economists almost universally favor a uniform carbon price. This leaves two main choices:
- Quantities: National permit allotments (aka cap-and-trade)
- Price: A uniform price commitment (aka global pricing)
Under scheme 1, a country’s emissions are not capped and it does not have any meaningful target. Rather countries receive a certain number of free permits to emit, which they can use or trade.
Under scheme 2, a country can use cap-and-trade, fossil taxes or any hybrid scheme in order to achieve the global price.
This section (including 3 sub-pages) compares the two approaches. Three major design areas must be considered:
A poor approach can result in a nearly useless agreement or block any agreement at all. For 20 years the quantity approach blocked any global agreement agreement, but now with even less structure, a vacuous agreement may be reached.
Pro Price: The argument for price negotiations is that (1) it simplifies negotiatioin, and (2) it causes countries to (largely) internalize the climate externality.
Pro Permits: The argument that a strong quantities agreement is easier to reach seems not to have been made. This approach was not designed with negotiations in mind.
Compliance generally requires measurement and incentives. Here we focus on measurement and on motives to interfere with measurement.
Price problems: The most significant problem may be the possibility of surreptitious carbon subsidies.
Permit problems: The most significant problem may be tracking permits. But even if they are tracked, they can do damage in countries with perfect compliance.
If poor countries are to accept a high price and its associated dead-weight loss, they will need to be compensated. This can be accomplished with free permits or cash.
Pro Permits: Free permits are more opaque than dollar transfers, so the transfers should be better tolerated by the public in the rich countries.
Con Permits: The same illusion that makes permits opaque to rich populations also makes them opaque to the recipients and to environmentalists. These illusions make transfers more problematic. And illusions may not be durable enough for multi-decade treaties.
In the view of this site’s authors, there is no clear winner with regard to compliance and compensation. Nonetheless, we would score a price commitment slightly higher on both counts.
Regarding negotiations, we believe a uniform price commitment is the hands-down winner. In this regard we agree with Nordhaus, Stiglitz, Cooper and Weitzman, that negotiating a set of strong quantity agreements is nearly impossible to imagine. The 20-year Kyoto agreement seems to confirm this view, and indications are the Paris agreement will re-confirm it.
In contrast, a strong price agreement appears to be far easier to negotiate. This should not be terribly surprising, since it was designed to make negotiations as easy as possible, while no consideration was given to the negotiation game when the quantity approach was selected.