Combet’s Carbon Incompetence

Warwick J. McKibbin
Warwick McKibbin
Warwick J. McKibbin Former expert - Economic Studies, Center on Regulation and Markets, Distinguished Professor of Economics & Public Policy - Crawford School of Public Policy, The Australian National University

August 30, 2012

The federal government’s announcement that the proposed floor price on carbon would be replaced by a deal to be part of the European emissions trading system in 2015 is astounding.

It shows a complete lack of understanding of what good climate policy should be and what is in Australia’s national interest.

Worse, it raises the economic costs of the existing carbon pricing policy because it creates even greater uncertainty about the price of carbon in future years. It also creates real concern about whether the government knows what it is doing, which adds to sovereign risk.

A minority government, seeking longevity by making whatever concessions are required to whatever sectional interest presses hardest, is clearly the basis for present policy design in Australia.

Vested interests have been allowed to chip away at the carbon price scheme just as they have at most other good ideas, and in the end most Australians are worse off.

It is one thing to make large-scale economic errors when the world economy is giving Australia several per cent of gross domestic product in extra revenue each year. It is another to plan errors for future years when the global economy is looking decidedly uncertain.

In the case of carbon pricing, the idea the Australian scheme should be linked to the European carbon trading scheme is equivalent to the idea the Australian dollar should join the euro zone.

This might be appealing to the government. After all, Australia ratified the Kyoto Protocol just as it was to become redundant and many countries were planning to announce their inability to achieve Kyoto targets at the Copenhagen climate conference. Australia is joining the European carbon scheme just as it has been demonstrated to being one of many policy failures in Europe.

Surely now is not the time to subject Australia to economic shocks out of Europe through an additional channel of the price of carbon. By joining the euro zone, we would complete the trifecta of fundamental policy errors and we could then blame someone else for our economic failures. This may be politically appealing, but it is also appalling public policy.

Carbon rights are like currencies.

The value of a carbon permit depends on the credibility of the government verifying that the carbon right is backed by an emission reduction. Just like money, the only value in an emission permit is the value given to it by a government’s credibility.

The single currency in Europe is under pressure because some governments within the euro zone have not followed policies that support the value of the currency they have created. This lack of credibility not only brings down the economy causing the problem, but it can bring down the entire currency unit because a euro is a euro and its value depends on the credibility of all governments in the system.

The same idea applies to the widespread trading in emissions rights across countries.

The global system is vulnerable to the bad behaviour of a single big player in the carbon permit market. At a time when Europe’s economic judgment is widely questioned, the federal government gives up the right to determine its own carbon price and give that right to Europe. The only case for this is that Europe has greater credibility in policy design and pricing than Australia. This may be true – for now.

The enormous uncertainty over the future of the single currency project in Europe shows why policy design under uncertainty is so important. To expose Australia to the European carbon trading system is a pure cost to the Australian economy. To have a carbon price at $23 a tonne, rising to $29 per tonne in 2015 then falling into a potential abyss, is bad for investment in energy technologies. Yet the solution to climate change will largely be driven by investment in such technologies.

If joining the European trading mechanism is such a good idea in 2015, why not join now? One reason is that the government made an error in providing compensation based on estimated revenue so that whatever happens to the carbon pricing system, the compensation will still need to be paid. Another error is in understanding that the world is highly uncertain and policy should not be made based on a punt about the future. Policy should be robust to different futures.

Australia’s climate policy design has been a farce – and it keeps getting worse.