It is easy to see why political leaders are reluctant to let markets run things. Unconstrained buying and selling usually gets away from itself, careering towards the lowest denominator, the financial bottom line.
Even those of a conservative persuasion who often understand how markets work can be wary of the unfettered force of rapid growth. They know that growth increases the risk of collapse when commodities of the day become scarce as they inevitably do. Unleash these volatile forces at your peril.
So here we are in Australia about to embark on a new market mechanism, the carbon price. From 1 July 2012 the top 500 emitters of greenhouse gases will, at the end of each financial year, have to pay for permits to cover their emissions.
At first the government will sell permits at a fixed price of $24. Then, after three years, permits will be priced by supply and demand through an auction mechanism. And just to make sure the market doesn’t go haywire the government will control the permit supply and set a price floor and a ceiling for at least three years.
If the price bombs, liable emitters will have pay extra to true up to the floor price.
The carbon price mechanism also offers the option of creating credits from approved emission reduction activities under the Carbon Farming Initiative. Naturally it is not really carbon farming as the bulk of activity will be in landfill gas and tree planting. The problem here is where the money goes. In simple terms emitters buying credits spend their money in the market but they buy permits from government. Too many credits and the revenues fail to match the commitments government has made to ensure passage of the policy in the first place.
Why all the constraints?
The answer is that this is not really a market mechanism, even though it looks like one. It is actually a policy to reduce “pollution” by using financial cost to change behaviour. The market part is just a way to try and wield the policy instrument with an even hand.
The risk, of course, is that keeping all that market power in check takes away most of the benefit too.
It’s a bit like having a guard dog on a chain. The burglar hears the growls and barks but if he trusts the chain will hold, there is no danger and he can pass into the house to pilfer the silver. Soon enough the owner realizes the risk taken by leaving the dog on a leash.
So what should happen? Well some honesty first. Despite the rhetoric, a carbon price is not about the atmosphere or saving the planet from global warming. It is the first of many steps in the transition of the economy away from dependence on fossil fuels. A vital step it must be said, although not the only one.
Pricing carbon is a way to foreshadow the economic costs of transition, to get us used to the pain before it really starts to hurt, let’s say when oil is $200 a barrel. It also gets the transition started earlier than it might if it were left to unfettered market forces. Ironically, it also protects some of the assets that create the emissions by giving them a longer life. It is a choice of leadership that sees its role as smoothing the inevitable bumps in the economic road.
Obviously reducing emissions is also a smart hedge on the global warming issue.
Now we know what the whole business is about, maybe we can let the mechanism run.