Carbon price Vs government funded research - climate change debates

The failure of the US Congress to arrive at an agreement on a climate change bill, has generated another debate about the way ahead with addressing the problem.

The dominant consensus approach to combat climate change have revolved around putting a price to carbon, through carbon tax or cap-and-trade, that would encourage people and businesses into embracing cleaner energy technologies. They advocate this in view of the impossibility of internalizing the significant amount of negative externalities generated by carbon fuels and the prevailing higher prices of cleaner energies.

However, a recent proposal by Michael Shellenberger and Ted Nordhaus of the Breakthrough Institute, takes a different path and argue in favor of greater government funding for clean-energy research. They make three points in support of their claim. One, as the US Climate Change Bill shows, the political economy of raising the price of carbon is difficult, even impossible. Second, the results of the biggest experiment with increasing the price of carbon, the European Union Emission Trading System (EU ETS), have been disappointing. Third, given the impossibility of privately capturing all the benefits of any major innovation, history shows that major technological breakthroughs in all sectors have come through government support for research. They call for

"...increasing federal innovation investment from roughly $4 today to $25 billion annually, and using military procurement, new, disciplined deployment incentives, and public-private hubs to achieve both incremental improvements and breakthroughs in clean energy technologies."

In the circumstances, I cannot but agree completely with David Leonhardt that "in the long term, a carbon price and more research funding are both important parts of the response to climate change". Or to quote Prof Robert Stavins,

"Carbon-pricing – whether carbon taxes or cap-and-trade – will be an essential part of any truly meaningful national climate policy. Likewise, to address the "R&D market failure", direct technology innovation policies will also be required. Both are necessary. Neither is sufficient. These are complements, not substitutes."

Or from Michael Shellenberger and Ted Nordhaus themselves,

"A technology-first strategy is not a technology-only strategy. Cheaper and better clean energy technologies are not a substitute for pricing, regulatory, public procurement or other policies that will be necessary to make a full transition from fossil fuel based technologies to low carbon technologies."

As an aside, the new report points out that, after accounting for macro-economic factors, the trends in European emissions are nearly indistinguishable from business-as-usual emissions. They use this to question the efficacy of carbon pricing strategies to addressing climate change. Two observations on this

1. Like the case with the debate surrounding the economic impact of the fiscal and monetary expansion in the US (the austerians point to the high unemployment rate and weak economy to claim that it had no impact), the results of the EU ETS cannot be easily isolated. Given the difficulty of accurately measuring emissions, there are several questions that have to be answered before we can make the claim that EU ETS has had no impact. For example, it is very much possible that without the EU ETS, the emissions would have been even higher.

2. A failure of EU ETS cannot be extrapolated to declare the failure of all carbon-pricing, even all cap-and-trade, systems. It is now well-established that the EU ETS contained several distortions, including the initial generous allocations of allowances and the liberal standards for evaluating projects eligible to receive carbon permits.

Such claims are an example of a cognitive bias called representativeness heuristic - people judge the probability or frequency of a hypothesis by considering how much the hypothesis resembles available data as opposed to using a Bayesian calculation. The high-profile nature of the EU ETS and it close attachment with the cap-and-trade movement meant that its failure (or even allegations) naturally led to questions being raised about the movement itself.