If nothing else, the cap and trade strategy for climate change might at least give us our next bubble.

First - a great animation on Cap & Trade. 

As discussed in the first part of this note, the global community has 'decided' (really it is the business leaders and political leaders who have decided for all of us) that the best way forward is Cap and Trade – that modeling carbon emissions as a commodity and using the market forces to regulate carbon pollution will be the best way forward.

However, a number of critiques have been raised (by a variety of environmental and economic experts). For one, market regulation, and trading of carbon emissions, is the perfect candidate for the next bubble. It is a commodity that is scarce, whose value can be easily pushed up, with financial analysts already clamoring. Thankfully – for now – it is to be regulated by governments. However, leaving that door slightly open allows for the potential that tomorrow we will see derivatives based on carbon emissions. Now one could argue that pushing up the price of carbon emissions through speculative trading might be a good thing – it will actually make it more expensive to give off extra units of emission. However, like in the real estate bubble (or the IT bubble), it can only come with lax regulations that make accounting dubious. In the end, the market will find that the speculative numbers are more real than the emission units.

That also brings us the the discussion of accounting for units, in the first place. The model of credit is quite dubious. Companies will receive credit for reducing expansion plans. So now, companies can claim they were planning on 200% expansion and will now only expand by 100% and receive credit. Companies will also receive credit for sequestering carbon. Thus, a large corporation in Malaysia will receive credit for decimating the rainforest and replacing it with a monoculture of fast growing trees – it can claim it sequestered emissions by forestation. More importantly, it is not clear how sequestration will be audited – how can any agency fraction?

In fact, in this model, a key question is – what will be the emission levels to begin with and who will get credit for what. The answer – it has been tentatively decided – is that all companies will be allowed to continue at their current models with a timed reduction in emissions over next four decades. Thus, high polluting companies benefit from having polluted high in the first place – they get permits for the levels at which they have polluted. So low polluters lose at the outset. Many in the third world – who have often been the recipients of pollutant dumping (not just carbon emissions) are asking why those who have polluted most are not paying for it?

There are major problems with this strategy for climate change – and the reasons described above take away from effective solutions. It continues to subsidize polluters – it penalizes those who have not polluted and provides economic advantage to those who have polluted. The supporters of the Cap and Trade – the market model – believe that this is a solution and that even though all of the above concerns may be true, we need to just go ahead with this. That injustices driven by cap and trade are minor – we cannot be bothered by such trivialities while the planet is at risk.

They forget that in fact, those who are at the receiving end of such injustice have been at the receiving end of pollution dumping for decades. While proponents of the Cap and Trade love this strategy since it does not affect their day to day life – or at best minimally affects their lives – dumping of pollutants has wreaked havoc on the lives of many already. Their unwillingness to recognize this or to brush aside such criticism is no different than the Bushism – you are with us or against us. It is the same idea – any criticism implies you do not really care about climate change.

In fact, the critics of climate change have elements of a more complex solution that acknowledges that climate change is a complex problem – with social, political and economic dimensions – that cannot be solved purely by an economic solution. It must begin by recognizing that this is a serious threat and business as before is not a solution. That a solution has to recognize the limits of resources, hence the limits of growth and thus begin with cutting back on levels of consumption. However, to much of the wealthy (who really make the decisions), that is out of scope. So this is the best solution that will be implemented. Whether it works or not.

- Sanat Mohanty