Linking carbon markets will be difficult
A new article in Climate Policy looks systematically at the political economy of the diffusion of emissions trading systems (ETS) and has sobering implications for the vision of global carbon-market linking.
Ever since the middle of the 1990s when serious efforts were made to promote the use of emissions trading for carbon, it has been widely assumed that the likely policy outcome eventually would involve extensively linked international carbon markets. By this logic, the many different national and regional emissions trading initiatives were merely waystations—eventually to be combined into larger international markets, perhaps even a single global carbon market.
Contrary to these expectations, the new study finds that emissions trading has remained a domestic or regional policy instrument with diverging designs on key features. Co-authored by FNI research professors Lars H. Gulbrandsen and Jørgen Wettestad, professor David G. Victor and professor Arild Underdal, the article builds on findings from the ETS Diffusion project, which examined most of the key ETS that are, or have been, in operation worldwide: the EU ETS, the Regional Greenhouse Gas Initiative (RGGI) on the US East Coast, California, Tokyo, New Zealand, Australia, China (regional/city pilots and forthcoming nationwide system), South Korea and Kazakhstan.
While the architects of these systems have been aware of other designs — especially the EU ETS, the largest and earliest major carbon market — they have purposely adjusted designs to reflect local political and administrative goals. This finding has sobering implications for those hoping for unfettered linkages and the emergence of a global carbon market. As Gulbrandsen explains:
Different caps and baselines, different coverages and offset rules, different price-management mechanisms and monitoring and enforcement rules. All this means that carbon market linking is likely to be very difficult'.
Based on this finding, the authors discuss several policy insights and directions for future research on carbon-markets linking. First and foremost, the diversity of local politics means that researchers must contend with the fact that there are many complex domestic processes and mechanisms to uncover and understand. There is clearly a need for more research on how design choices are rooted in domestic conditions – and to search for patterns in how those domestic factors shape outcomes. Wettestad elaborates:
Our research shows that linking faces a considerable political feasibility challenge. Despite the obvious and likely economic benefits, the resistance of central political actors, due to uncertainty about distributional effects, can render linking efforts complicated, even futile’.
Read the new study here: The political roots of divergence in carbon market design: implications for linking
A second front for new research is to investigate whether one of the central findings – design divergence rather than convergence – holds for cases not analyzed here, like the emerging systems in Thailand, Vietnam and South Africa. Perhaps these new cases—and other systems in small countries that must be price takers in any linked market—will converge around a better design model that has been refined through more experience. For small markets, just like in any global trade, the costs of not being linked to the outside world are larger.
That is why small systems have been the first to link with larger systems, such as Switzerland and the EU ETS. Other examples include the link between Quebec and California and the planned link between the shelved Australian system and the EU ETS’, Gulbrandsen explains.
Simple is better?
Third, additional research—with an eye to policy application—is needed to know more about the implications for the design of linking mechanisms. The authors maintain that although unfettered linkage is unlikely, there is still pressure for linkage in some jurisdictions, and the economic logic for doing so is powerful. With success in some linking efforts the interest groups that favour linking – along with the evidence and resources they can use to advance their case – can grow.
With that backdrop, the authors make the case that it would be possible to explore design of linkage systems that do not attempt full-blown linking but rather aim for political simplicity, such as harmonization of floor prices in systems with price-management mechanisms and the creation of safety valves around linking systems.
The Evolution of Carbon Markets - Design and Diffusion
Make it or break it for carbon trading?