Who Killed Cap-and-Trade?

In a recent article in the New York Times, John Broder asks “Why did cap-and-trade die?” and responds that “it was done in by the weak economy, the Wall Street meltdown, determined industry opposition and its own complexity.”  Mr. Broder’s analysis is concise and insightful, and I recommend it to readers.  But I think there’s one factor that is more important than all those mentioned above in causing cap-and-trade to have changed from politically correct to politically anathema in just nine months.  Before turning to that, however, I would like to question the premise of my own essay.

Is Cap-and-Trade Really Dead?

Although cap-and-trade has fallen dramatically in political favor in Washington as the U.S. answer to climate change, this approach to reducing carbon dioxide (CO2) emissions is by no means “dead.”

The evolving Kerry-Graham-Lieberman legislation has a cap-and-trade system at its heart for the electricity-generation sector, with other sectors to be phased in later (and it employs another market-based approach, a series of fuel taxes for the transportation sector linked to the market price for allowances).  Of course, due to the evolving political climate, the three Senators will probably not call their system “cap-and-trade,” but will give it some other creative label.

The competitor proposal from Senators Cantwell and Collinsthe CLEAR Act — has been labeled by those Senators as a “cap-and-dividend” approach, but it is nothing more nor less than a cap-and-trade system with a particular allocation mechanism (100% auction) and a particular use of revenues (75% directly rebated to households) — and, it should be mentioned, some unfortunate and unnecessary restrictions on allowance trading.

And we should not forget that cap-and-trade continues to emerge as the preferred policy instrument to address climate change emissions throughout the industrialized world — in Europe, Australia, New Zealand, and Japan (as I wrote about in a recent post).

But back to the main story — the dramatic change in the political reception given in Washington to this cost-effective approach to environmental protection.

A Rapid Descent From Politically Correct to Politically Anathema

Among factors causing this change were:  the economic recession; the financial crisis (linked, in part, with real and perceived abuses in financial markets) which thereby caused great suspicion about markets in general and in particular about trading in intangible assets such as emission allowances; and the complex nature of the Waxman-Markey legislation (which is mainly not about cap-and-trade, but various regulatory approaches).

But the most important factor — by far — which led to the change from politically correct to politically anathema was the simple fact that cap-and-trade was the approach that was receiving the most serious consideration, indeed the approach that had been passed by one of the houses of Congress.  This brought not only great scrutiny of the approach, but — more important — it meant that all of the hostility to action on climate change, mainly but not exclusively from Republicans and coal-state Democrats, was targeted at the policy du jour — cap-and-trade.

The same fate would have befallen any front-running climate policy.

Does anyone really believe that if a carbon tax had been the major policy being considered in the House and Senate that it would have received a more favorable rating from climate-action skeptics on the right?  If there’s any doubt about that, take note that Republicans in the Congress were unified and successful in demonizing cap-and-trade as “cap-and-tax.”

Likewise, if a multi-faceted regulatory approach (that would have been vastly more costly for what would be achieved) had been the policy under consideration, would it have garnered greater political support?  Of course not.  If there is doubt about that, just observe the solid Republican Congressional hostility (and some announced Democratic opposition) to the CO2 regulatory pathway that EPA has announced under its endangerment finding in response to the U.S. Supreme Court decision in Massachusetts vs. EPA.

(There’s a minor caveat, namely, that environmental policy approaches that hide their costs frequently are politically favored over policies that make their costs visible, even if the former policy is actually more costly.  A prime example is the broad political support for Corporate Average Fuel Economy (CAFE) standards, relative to the more effective and less costly option of gasoline taxes.  Of course, cap-and-trade can be said to obscure its costs relative to a carbon tax, but that hardly made much difference once opponents succeeded in labeling it “cap-and-tax.”)

In general, any climate policy approach — if it was meaningful in its objectives and had any chance of being enacted — would have become the prime target of political skepticism and scorn.  This has been the fate of cap-and-trade over the past nine months.

Why is Political Support for Climate Policy Action So Low in the United States?

If much of the political hostility directed at cap-and-trade proposals in Washington has largely been due to hostility towards climate policy in general, this raises a further question, namely, why has there been so little political support in Washington for climate policy in general.  Several reasons can be identified.

For one thing, U.S. public support on this issue has decreased significantly, as has been validated by a number of reliable polls, including from the Gallup Organization.  Indeed, in January of this year, a Pew Research Center poll found that “dealing with global warming” was ranked 21st among 21 possible priorities for the President and Congress.  (It should be noted some polls are not consistent with these.)  This drop in public support is itself at least partly due to the state of the national economy, as public enthusiasm about environmental action has — for many decades — been found to be inversely correlated with various measures of national economic well-being.

Although the lagging economy (and consequent unemployment) is likely the major factor explaining the fall in public support for climate policy action, other contributing factors have been the so-called Climategate episode of leaked e-mails from the University of East Anglia and the damaged credibility of the Intergovernmental Panel on Climate Change (IPCC) due to several errors in recent reports.

Furthermore, the nature of the climate change problem itself helps to explain the relative apathy among the U.S. public.  Nearly all of our major environmental laws have been passed in the wake of highly-publicized environmental events or “disasters,” ranging from Love Canal to the Cuyahoga River.

But the day after Cleveland’s Cuyahoga River caught on fire in 1969, no article in The Cleveland Plain Dealer commented that “the cause was uncertain, because rivers periodically catch on fire from natural causes.”  On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries.  A direct consequence of the “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different.  Unlike the environmental threats addressed successfully in past legislation, climate change is essentially unobservable.  You and I observe the weather, not the climate (note the dramatic difference of opinion about the reality of climate change between climatologists and television weathercasters).  Until there is an obvious and sudden event — such as a loss of part of the Antarctic ice sheet leading to a disastrous sea-level rise — it’s unlikely that public opinion in the United States will provide the bottom-up demand for action that has inspired previous Congressional action on the environment over the past forty years.

Finally, it should be acknowledged that the fiercely partisan political climate in Washington has completed the gradual erosion of the bi-partisan coalitions that had enacted key environmental laws over four decades.  Add to this the commitment by the opposition party to deny the President any (more) political victories in this year of mid-term Congressional elections, and the possibility of progressive climate policy action appears unlikely in the short term.

An Open-Ended Question

There are probably other factors that help explain the fall in public and political support for climate policy action, as well as the changed politics of cap-and-trade.  I suspect that readers will tell me about these.


Unintended Consequences of Government Policies: The Depletion of America’s Wetlands

Private land-use decisions can be affected dramatically by public investments in highways, waterways, flood control, or other infrastructure.  The large movement of jobs from central cities to suburbs in the postwar United States and the ongoing destruction of Amazon rain forests have occurred with major public investment in supporting infrastructure.  As these examples suggest, private land-use decisions can generate major environmental and social externalities – or, in common language, unintended consequences.

In an analysis that appeared in 1990 in the American Economic Review, Adam Jaffe of Brandeis University and I demonstrated that the depletion of forested wetlands in the Mississippi Valley – an important environmental problem and a North American precursor to the loss of South American rain forests – was exacerbated by Federal water-project investments, despite explicit Federal policy to protect wetlands.

Wetland Losses

Forested wetlands are among the world’s most productive ecosystems, providing improved water quality, erosion control, floodwater storage, timber, wildlife habitat, and recreational opportunities.  Their depletion globally is a serious problem; and preservation and protection of wetlands have been major Federal environmental policy goals for forty years.

From the 1950s through the mid-1970s, over one-half million acres of U.S. wetlands were lost each year.  This rate slowed greatly in subsequent years, averaging approximately 60 thousand acres lost per year in the lower 48 states from 1986 through 1997.  And by 2006, the Bush administration’s Secretary of the Interior, Gale Norton, was able to announce a net gain in wetland acreage in the United Sates, due to restoration and creation activities surpassing wetland losses.

What Caused the Observed Losses?

What were the causes of the huge annual losses of wetlands in the earlier years?  That question and our analysis are as germane today as in 1990, because of lessons that have emerged about the unintended consequences of public investments.

The largest remaining wetland habitat in the continental United States is the bottomland hardwood forest of the Lower Mississippi Alluvial Plain.  Originally covering 26 million acres in seven states, this resource was reduced to about 12 million acres by 1937.  By 1990, another 7 million acres had been cleared, primarily for conversion to cropland.

The owner of a wetland parcel faces an economic decision involving revenues from the parcel in its natural state (primarily from timber), costs of conversion (the cost of clearing the land minus the resulting forestry windfall), and expected revenues from agriculture.  Agricultural revenues depend on prices, yields, and, significantly, the drainage and flooding frequency of the land.  Needless to say, landowners typically do not consider the positive environmental externalities generated by wetlands; thus conversion may occur more often than is socially optimal.

Such externalities are the motivation for Federal policy aimed at protecting wetlands, as embodied in the Clean Water Act.  Nevertheless, the Federal government engaged in major public investment activities, in the form of U.S. Army Corps of Engineers and U.S. Soil Conservation Service flood-control and drainage projects, which appeared to make agriculture more attractive and thereby encourage wetland depletion.  The significance of this effect had long been disputed by the agencies which construct and maintain these projects; they attributed the extensive conversion exclusively to rising agricultural prices.

In an econometric (statistical) analysis of data from Arkansas, Mississippi, and Louisiana, from 1935 to 1984, Jaffe and I sought to sort out the effects of Federal projects and other economic forces.  We discovered that these public investments were a very substantial factor causing conversion of wetlands to agriculture, with between 30 and 50 percent of the total wetland depletion over those five decades due to the Federal projects.

More broadly, four conclusions emerged from our analysis.  First, landowners had responded to economic incentives in their land-use decisions.  Second, construction of Federal flood-control and drainage projects caused a higher rate of conversion of forested wetlands to croplands than would have occurred in the absence of projects, leading to the depletion of an additional 1.25 million acres of wetlands.  Third, Federal projects had this impact because they made agriculture feasible on land where it had previously been infeasible, and because, on average, they improved the quality of feasible land.  Fourth, adjustment of land use to economic conditions was gradual.

Government Working at Cross-Purposes

The analysis highlighted a striking inconsistency in the Federal government’s approach to wetlands.  In articulated policies, laws, and regulations, the government recognized the positive externalities associated with some wetlands, with the George H.W. Bush administration first enunciating a “no net loss of wetlands” policy.  But public investments in wetlands – in the form of flood-control and drainage projects – had created major incentives to convert these areas to alternative uses.  The government had been working at cross-purposes.

The conclusion that major public infrastructure investments affect private land-use decisions (thereby often generating negative externalities) may not be a surprise to some readers, but it was the 1990 analysis described here that first provided rigorous evidence which contrasted sharply with the accepted wisdom among policy makers.

The Ongoing Importance of Induced Land-Use Changes

As wetlands, tropical rain forests, barrier islands, and other sensitive environmental areas become more scarce, their marginal social value rises.  In general, if induced land-use changes are not considered, the country will engage in more public investment programs whose net social benefits are negative.


Policies Can Work in Strange Ways

Whether the policy domain is global climate change or local hazardous waste, it’s exceptionally important to understand the interaction between public policies and technological change in order to assess the effects of laws and regulations on environmental performance.  Several years ago, my colleagues ­- Professor Lori Bennear of Duke University and Professor Nolan Miller of the University of Illinois – examined with me the effects of regulation on technological change in chlorine manufacturing by focusing on the diffusion of membrane-cell technology, widely viewed as environmentally superior to both mercury-cell and diaphragm-cell technologies.  Our results were both interesting and surprising, and merit thinking about in the context of current policy discussions and debates in Washington.

The chlorine manufacturing industry had experienced a substantial shift over time toward the membrane technology. Two different processes drove this shift:  adoption of cleaner technologies at existing plants (that is, adoption), and the closing of facilities using diaphragm and mercury cells (in other words, exit).  In our study, we considered the effects of both direct regulation of chlorine manufacturing and regulation of downstream uses of chlorine.    (By the way, you can read a more detailed version of this story in our article in the American Economic Review Papers and Proceedings, volume 93, 2003, pp. 431-435.)

In 1972, a widely publicized incident of mercury poisoning in Minamata Bay, Japan, led the Japanese government to prohibit the use of mercury cells for chlorine production. The United States did not follow suit, but it did impose more stringent constraints on mercury-cell units during the early 1970’s. Subsequently, chlorine manufacturing became subject to increased regulation under the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation, and Liability Act.  In addition, chlorine manufacturing became subject to public-disclosure requirements under the Toxics Release Inventory.

In addition to regulation of the chlorine manufacturing process, there was also increased environmental pressure on industries that used chlorine as an input. This indirect regulation was potentially important for choices of chlorine manufacturing technology because a large share of chlorine was and is manufactured for onsite use in the production of other products. Changes in regulations in downstream industries can have substantial impacts on the demand for chlorine and thereby affect the rate of entry and exit of chlorine production plants.

Two major indirect regulations altered the demand for chlorine. One was the Montreal Protocol, which regulated the production of ozone-depleting chemicals, such as chlorofluorocarbons (CFCs), for which chlorine is a key ingredient. The other important indirect regulation was the “Cluster Rule,” which tightened restrictions on the release of chlorinated compounds from pulp and paper mills to both water and air. This led to increased interest by the industry in non-chlorine bleaching agents, which in turn affected the economic viability of some chlorine plants.

In our econometric (statistical) analysis, we analyzed the effects of economic and regulatory factors on adoption and exit decisions by chlorine manufacturing plants from 1976 to 2001.  For our analysis of adoption, we employed data on 51 facilities, eight of which had adopted the membrane technology during the period we investigated.

We found that the effects of the regulations on the likelihood of adopting membrane technology were not statistically significant.  Mercury plants, which were subject to stringent regulation for water, air, and hazardous-waste removal, were no more likely to switch to the membrane technology than diaphragm plants. Similarly, TRI reporting appeared to have had no significant effect on adoption decisions.

We also examined what caused plants to exit the industry, with data on 55 facilities, 21 of which ceased operations between 1976 and 2001. Some interesting and quite striking patterns emerged. Regulations clearly explained some of the exit behavior.  In particular, indirect regulations of the end-uses of chlorine accelerated shutdowns in some industries. Facilities affected by the pulp and paper cluster rule and the Montreal Protocol were substantially more likely to shut down than were other facilities.

It is good to remember that the diffusion of new technology is the result of a combination of adoption at existing facilities and entry and exit of facilities with various technologies in place. In the case of chlorine manufacturing, our results indicated that regulatory factors did not have a significant effect on the decision to adopt the greener technology at existing plants. On the other hand, indirect regulation of the end-uses of chlorine accelerated facility closures significantly, and thereby increased the share of plants using the cleaner, membrane technology for chlorine production.

Environmental regulation did affect technological change, but not in the way many people assume it does. It did so not by encouraging the adoption of some technology by existing facilities, but by reducing the demand for a product and hence encouraging the shutdown of facilities using environmentally inferior options.  This is a legitimate way for policies to operate, although it’s one most politicians would probably prefer not to recognize.