As the Senate weighs its climate and energy policy options, a new study out of Harvard University evaluates the European Emission Trading System to better understand how a cap-and-trade system would work in the United States. During today's OnPoint, Richard Cooper, a professor of international economics at Harvard University and author of the study, explains which elements of the ETS he believes should be dropped from Senate proposals. He also discusses the successes of the European ETS.
Monica Trauzzi: Welcome to the show. I'm Monica Trauzzi. Joining me today is Dr. Richard Cooper, professor of International Economics at Harvard University. Dr. Cooper, thanks for coming on the show.
Richard Cooper: Thank you for having me.
Monica Trauzzi: Dr. Cooper, you've just released a new study evaluating the European emissions trading scheme to better understand how a cap and trade might work here in the U.S. The ETS has come under a lot of scrutiny and criticism. Some have said that it's failed. How can the U.S. use Europe's experience as it begins to shape and craft its legislation?
Richard Cooper: Well, I think the first thing to be said about the European Trading System, ETS as it's called for short, which is trade in permits to emit greenhouse gases, so far overwhelmingly carbon dioxide. The first thing to say about it is they've actually made it work. They had an experimental period for three years. There were some bugs in it. They ironed out the bugs and now we're in what's called the commitment period under the Kyoto Protocol and the system is up and running. And, from a technical point of view, it seems to be running quite well. So, I think the first lesson to come out of Europe is that this is a system that, from a technical point of view, can be made to function and the Europeans have succeeded in that. And then, going beyond that, the question is what lessons might we learn from the European system? And I think there is one very important lesson to learn from it, which would apply to all cap-and-trade systems, and then another lesson, which we would like to learn, which is in addition to working technically, has it been effective? That is to say, has it done the job that it was set up to do? And, unhappily for many reasons, the period that we've had so far, 2008, 2009, we're now in 2010, has been a very unusual one, from an economic point of view, with the financial crisis and then followed by the economic recession, which hit many European countries even harder than it hit the United States, makes it very difficult to have a fair evaluation about whether the ETS has worked, in terms of its objectives. And we'll just have to wait until Europe has a recovery and see if it's doing anything significant to reduce carbon. Carbon emissions are way down in Europe, but they're way down overwhelmingly because of the recession and not because of the cap-and-trade system.
Monica Trauzzi: So, let's talk about some of the lessons learned. Economists and environmentalists have been concerned about many different aspects about the ETS, the volatility of prices being one of them. We saw the Europeans have a steep climb in prices and then a sudden drop all the way down to zero. That's a big risk. Does it pose too much of a risk and how do we manage that risk of the volatility?
Richard Cooper: Well, first the example you cite is a little unfair. It is historically accurate, but it's a little unfair in the sense that that was during their experimental period and they learned during that period that they over allocated the permits. They didn't know that at the outset, but it turned out to be the case. Once that was understood, the value went to zero because they could not be used after 2007 and so they had no value essentially. And under the current arrangements, what's called Phase 2 in European lingo, the permits can be used not only for the next several years, but all the way to 2020. And so if they have any value in the future, they're going to have value in the present because people can hold them, buy them and hold them. So, I think one should not generalize too much from that experimental period, Phase 1 the Europeans call it. But, nonetheless, it is true that we saw a big run-up in prices during what was still a boom period of the first half of 2008 and then a big drop in prices, not to zero, but to less than $10 a ton of carbon, right to emit carbon dioxide. And then they've gone up gradually since then, but they're still only about half the peak of mid-2008. And so this is not the only volatility we see in economies. We see it in copper prices, we see it in oil prices, we see other commodities especially which have volatility, and one has to ask the question whether this volatility is harmful, either to the firms who have to get the permits to emit or is it harmful to the objective? And I think a qualified answer to both of those questions is, yes, it is harmful and that should lead us and anyone else thinking of having a cap-and-trade program of how to limit that volatility. And there are a number of suggestions on the table to limit the extreme highs or even, in principle, the extreme lows.
Monica Trauzzi: And the allocation of allowances is going to be a key factor in all of this and it's one of the biggest debates that we're seeing here in the U.S., how much and to who? Where should these allowances go? So, is there any additional clarity that you can give us based on the research you did on the ETS about where these allocations should be going?
Richard Cooper: This, I think, is a very big issue and a very big fly in the European system as it's currently constituted. Europeans, of course, are aware of it and thinking about alternatives, but the European system, in its overall framework, covers all 27 member states of the European Union. But, while the overall framework was set, the allocation was left to the national authority, so you have 27 different regimes. And, not surprisingly perhaps, the national authorities, in various ways, tried to game the system. First they often had too many permits, the Eurocrats in Brussels scaled those back, but they didn't look at the details of allocations and the bottom line is that many European countries over allocated to some sectors, particularly manufacturing, iron and steel, bricks and ceramics, pulp and paper. And the sector that was typically under allocated to was the power generating sector, which is the biggest source of CO2. So, basically, this system amounted to a subsidy from the power system, power generating system to the manufacturing sector, I mean to generalize. The extent and distribution of the subsidy varied from country to country, so Germany is different from Italy, different from Spain, and so forth. But this has potentially very strong trade distorting effects, because say the steel industry in country X gets much more subsidy through the allocation of permits than the steel industry in country Y. And, of course both X and Y have an advantage relative to steel industries outside of the E.U., so it destroys both internal trade and external trade of the European Union. And this, I think, was a major flaw in what the Europeans call Phase 2 of their scheme.
Monica Trauzzi: We're almost out of time. I want to get this last question in relating back here to the U.S. Do you feel that the conversations that are happening in Congress right now adequately address and respond to the issues that we're seeing in Europe? Do you think things are on the right track here in the U.S.?
Richard Cooper: My own view is that things are largely on the wrong track in the U.S. and for this reason, not having to do with the Europe especially, but this is a global problem. China has become the largest emitter, surpassing the United States a few years ago. We cannot seriously address this problem without China cooperating, India, Brazil, other countries coming in behind. The cap-and-trade system, which the Europeans have adopted and which we're talking about, in my judgment, China will not engage in such a scheme and yet we need them. So, we need to think beyond the United States. We need to think about what will work in the world as a whole and we're not doing that. That's the major flaw. And then secondarily, if one plays the thought experiment of cap and trade elsewhere in the world, it is an absolute, for the reasons your earlier question suggested, it's an absolute set up for corruption. You have governments giving away pieces of paper that have value and while the Fins, I'm sure, can work that in a straightforward way and maybe even the United States can, I'm quite sure there are many countries in the world where it's going to be the cousin of the president or who pays the biggest fee. It's an absolute invitation, favoritism is built in and favoritism is just this far from corruption. And so I think it's an invitation for corruption in many other countries who have to participate in order to solve this problem. So, I think we're on the wrong track.
Monica Trauzzi: All right, we'll end it on that grim note. Thank you for coming on the show, I appreciate it.
Richard Cooper: Thank you for having me.
Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.
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